A government data processing center has been plagued in recent years by complaints from employees of back pain. Consultants have estimated that upgrading office furniture at a net cost of $425,000 would reduce the incidence and severity of back injuries, allowing the center to avoid medical care that currently costs $68,000 each year. They estimate that the new furniture would also provide yearly benefits of avoided losses in work time and employee comfort worth $18,000. The furniture would have a useful life of five years, after which it would have a positive salvage value equal to 10 percent of its initial net cost. The consultants made their estimates of avoided costs assuming that they would be treated as occurring at the beginning of each year.
In its investment decisions, the center uses a nominal discount rate of 9.5 percent and an assumed general inflation rate of 3 percent. It expects the inflation rate for medical care will run between 3 percent and 5 percent but is uncertain as to the exact rate. In other words, it is uncertain as to whether the cost of medical care will inflate at the same rate as other prices or rise 2 percent faster. Should the center purchase the new furniture?