Using the Integrative Application, create a spreadsheet for the financial analysis described in that application. Then, imagine that you need to walk your staff through this financial analysis. Walk them through the scenario and the financial analysis involved. Clearly identify whether this proposed capital project should be accepted or rejected:

The Scampini Clinic recently purchased a new ultrasound machine. The machine cost $22,500, and it is expected to generate net after-tax operating cash flows (including depreciation) of $6,250 per year, starting in year 1. The machine has a five-year expected life, and the clinics cost of capital is 10 percent. The expected salvage values of the machine at the end of each year are given in the following table:

Year: Salvage Value:

0 $22,500

1 $17,500

2 $14,000

3 $11,000

4 $5,000

5 $0

The clinic must decide whether to operate the machine until the end of its five-year physical life or earlier.

THE ANALYSIS:

The operating cash flows and salvage value for each year of the expected life of the ultrasound machine are as follows:

Year: Operating Cash Flow: Salvage Value:

0 ($22,500) $22,500

1 $6,250 $17,500

2 $6,250 $14,000

3 $6,250. $11,000

4 $6,250 $5,000

5 $6,250 $0

If the clinic operates the machine for one year only, the NPV of the investment at a cost of capital of 10 percent would be as follows:

NPV= $22,500 + ($6,250+ $17,500) / 1.10 =$909

= $22,500 + NPV (10%, $6,250 + $17,500) = $909

If the clinic operates the machine for two to five years, the NPV of the investment at a cost of capital of 10 percent would be as follows:

At 2 years: = $22,500 + NPV (10%, $6,250, $6,250 + $14,000) = $83

At 3 years: = $22,500 + NPV (10%, $6,250, $6,250, $6,250 + $11,000) = $1,307

At 4 years: = $22,500 + NPV (10%, $6,250, $6,250, $6,250, $6,250 + $5,000) = $727

At 5 years: = $22,500 + NPV (10%, $6,250, $6,250, $6,250, $6,250, $6,250 + $0) = $1,192

THE DECISION:

The clinic decided to operate the ultrasound machine for three years, which is when the NPV is maximized at $1,307. Positive salvage values can only raise the expected NPV and IRR of a project. However, negative salvage values (e.g., removal and disposal costs) could lower NPV and IRR.