The 2020 annual financial results of Apollo Diagnostics have revealed a decline in operating income. To overcome such a decline, an organization-wide cost control drive has been initiated by the company. The company has various revenue-producing centers, including X-ray and MRI units, pathological tests, and electrocardiogram and related tests. The administrator has been considering improving the X-ray and MRI units with more advanced and cost-effective machines. The infrastructural upgradation will cost $125,500. Its unique characteristics would generate additional cash operating income of $25,000 per year for the diagnostic center as a whole. 

The machines are expected to have a useful life of 8 years and may be sold at a terminal salvage value of $17,500. The machines require a constant inventory of some supplies and spare parts so that instant replacement of supplies and parts is possible. This will cost the center an additional investment of $3,500 at all times. However, the investment can be recovered fully at the end of the useful life of the machines. 

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

2. Compute the ARR on 

(a) The initial investment 

(b) The “average” investment. Assume straight-line depreciation.

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