Problem:
A not for profit business is evaluating the purchase of new diagnostic equipment. The equipment, which costs $600,000, has an expected life of five years and an estimated salvage value of $200,000 at that time. The equipment is expected to be used 15 times a day for 250 days a year for each year for each year of the projects life. On average, each procedure is expected to generate $80 in cash collections during the first year of use. Thus, revenues for Year 1 are estimated at 15 x 250 x $80 = $300,000.
Labor and maintenance costs are expected to be $100,000 during the first year of operation, while utilities will cost another $10,000 and cash overhead will increase by $5000 in Year 1. The cost for expendable supplies is expected to average $5 per procedure during the first year. All costs and revenues are expected to increase at a 5% inflation rate after the first year.
The center's corporate cost of capital is 10%.
a. Estimate the project's net cash flows over its five-year estimated life. Use the following as a guide:
Year
0 1 2 3 4 5
Equipment cost
Net revenues
Less: Labor/maint. Costs
Utilities costs
Supplies
Incremental overhead
Operating income
Equipment salvage value
Net cash flow
b. What are the project's NPV and IRR (assume average risk for the project)?
c. Assume the project is assessed to have high risk and the institution subtracts 3% points to adjust for project risk. Now, what is the project's NPV? Does the risk assessment change how the project's IRR is interpreted?