Suppose that California Imaging Center, 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 of the project’s life. On average, each procedure is expected to generate \($80\) in cash collections during the first year of use. Thus, net revenues for year 1 are estimated at 15 × 250 × \($80\) = \($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 \($5,000\) 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 percent inflation rate after the first year. The center’s corporate cost of capital is 10 percent.

a. Estimate the project’s net cash flows over its five-year estimated life.

b. What are the project’s NPV and IRR? (Assume for now that the project has average risk.)

c. Assume that the project is assessed to have high risk and that California Imaging Center adds or subtracts 3 percentage 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?

Transcribed Image Text:

0 Equipment cost Net revenues Less: Labor/maintenance costs Utilities costs Supplies Incremental overhead Operating income Equipment salvage value Net cash flow 1 2 Year 3 4 | 5 | | | |