Problem 2 (See Exhibit 14-3) Georgia Health Center, a for profit hospital, is evaluating the purchase...

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Problem 2 (See Exhibit 14-3) Georgia Health Center, a for profit hospital, is evaluating the purchase of a new diagnostic equipment. The equipment, which cost $500,000, has an expected life of five years and an estimated pretax salvage value of $100,000 at that time. The equipment is expected to be used 20 times a day for 240 days a year for each year of the project's life. On average, each procedure is expected to generate $60 in collections, which is net of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for Year 1 are estimated at 20 x 240 x $60= $288,000 Wages and Salaries are expected to be $110,000 during the first year of operation, while consulting fees will cost another $12,000. Maintenance & Utilities expense is expected to average $4 per procedure during the first year while cash overhead will be $3,000. All costs and revenues, except depreciation, are expected to increase at 8 percent inflation rate per year after the first year. The equipment falls into the MACRS five-year class for tax depreciation and is subject to the following depreciation allowances: Year Allowance 0.20 1 2 0.32 3 0.19 4 0.12 5 0.11 0.06 6 The hospital's tax rate is 25 percent, and its corporate cost of capital is 12%. See textbook, Exhibit 14-3. You can use Excel to complete this problem. If you do, please submit your homework document and the Excel file. a. Estimate the project's net cash flows over its five-year estimated life. Hint: complete the following table. Equipment cost 0 1 2 3 Net revenue Less: Wages & Salaries Consulting fees Maintenance & Utilities Cash overhead Depreciation Income before taxes Taxes (25%) Project's net income Plus: Depreciation Plus: Net salvage value Net Cash Flows b. What's the project's NPV? c. What's the project's IRR? d. Would you recommend the acquisition of this diagnostic equipment? Please explain. 4 5 Problem 2 (See Exhibit 14-3) Georgia Health Center, a for profit hospital, is evaluating the purchase of a new diagnostic equipment. The equipment, which cost $500,000, has an expected life of five years and an estimated pretax salvage value of $100,000 at that time. The equipment is expected to be used 20 times a day for 240 days a year for each year of the project's life. On average, each procedure is expected to generate $60 in collections, which is net of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for Year 1 are estimated at 20 x 240 x $60= $288,000 Wages and Salaries are expected to be $110,000 during the first year of operation, while consulting fees will cost another $12,000. Maintenance & Utilities expense is expected to average $4 per procedure during the first year while cash overhead will be $3,000. All costs and revenues, except depreciation, are expected to increase at 8 percent inflation rate per year after the first year. The equipment falls into the MACRS five-year class for tax depreciation and is subject to the following depreciation allowances: Year Allowance 0.20 1 2 0.32 3 0.19 4 0.12 5 0.11 0.06 6 The hospital's tax rate is 25 percent, and its corporate cost of capital is 12%. See textbook, Exhibit 14-3. You can use Excel to complete this problem. If you do, please submit your homework document and the Excel file. a. Estimate the project's net cash flows over its five-year estimated life. Hint: complete the following table. Equipment cost 0 1 2 3 Net revenue Less: Wages & Salaries Consulting fees Maintenance & Utilities Cash overhead Depreciation Income before taxes Taxes (25%) Project's net income Plus: Depreciation Plus: Net salvage value Net Cash Flows b. What's the project's NPV? c. What's the project's IRR? d. Would you recommend the acquisition of this diagnostic equipment? Please explain. 4 5