Museum Clinic has been under pressure to keep costs down. The clinic administrator has been managing various revenue-producing centers to maximize contributions to the recovery of the operating costs of the clinic as a whole. The administrator has been considering whether to buy a special-purpose CAT scan machine for $251,000. Its unique characteristics would generate additional cash operating income of $50,000 per year for the clinic as a whole.

The clinic expects the machine to have a useful life of 8 years and a terminal salvage value of $35,000. The machine is delicate. It requires a constant inventory of various supplies and spare parts. When the clinic uses some of these items, it instantly replaces them so it maintains an investment of $7,000 at all times. However, the clinic fully recovers this investment at the end of the useful life of the machine.

1. Compute NPV if the required rate of return is 10%.

2. Compute the ARR on (a) the initial investment and (b) the “average” investment. Assume straight-line depreciation.

3. Why might the administrator be reluctant to base her decision on the DCF model?