Dr. Whitley Avard, a plastic surgeon, had just returned from a conference in which she learned of

Question:

Dr. Whitley Avard, a plastic surgeon, had just returned from a conference in which she learned of a new surgical procedure for removing wrinkles around eyes, reducing the time to perform the normal procedure by 50 percent. Given her patient-load pressures, Dr. Avard is excited to try out the new technique. By decreasing the time spent on eye treatments or procedures, she can increase her total revenues by performing more services within a work period. Unfortunately, in order to implement the new procedure, special equipment costing $74,000 is needed. The equipment has an expected life of four years, with a salvage value of $6,000. Dr. Avard estimates that her cash revenues will increase by the following amounts:

Year Revenue Increases

1 $19,800

2 27,000

3 32,400

4 32,400

She also expects additional cash expenses amounting to $3,000 per year. The cost of capital is 12 percent. Assume that there are no income taxes.

Required:

1. Compute the payback period for the new equipment.

2. Compute the ARR.

3. Compute the NPV and IRR for the project. Should Dr. Avard purchase the new equipment? Should she be concerned about payback or the ARR in making this decision?

4. Before finalizing her decision, Dr. Avard decided to call two plastic surgeons who have been using the new procedure for the past six months. The conversations revealed a somewhat less glowing report than she received at the conference. The new procedure reduced the time required by about 25 percent rather than the advertised 50 percent. Dr. Avard estimated that the net operating cash flows of the procedure would be cut by one-third because of the extra time and cost involved (salvage value would be unaffected). Using this information, recompute the NPVof the project. What would you now recommend?

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...