Hospitals board of directors has approved of purchasing of a new equipment with
ID: 2630220 • Letter: H
Question
Hospitals board of directors has approved of purchasing of a new equipment with a capital investment of $400,000. The estimated life of the equipment is 10 years and during that period the estimated after-tax cash flows (EATCF) are given below. The investments required rate of return is 20%.
Year
0
1
2
3
4
5
6
7
8
9
10
EATCF
($1000)
-400
65
65
68
70
65
68
70
73
65
60
Evaluate this investment, in terms of:
a) Average rate of Return
b) Net Present Value
c) Profitability index
And whether or not it is acceptable and based on each method?
Year
0
1
2
3
4
5
6
7
8
9
10
EATCF
($1000)
-400
65
65
68
70
65
68
70
73
65
60
Explanation / Answer
a)
Average EATCF = (65+ 65 + 68 + 70 + 65 + 68 + 70 + 73 + 65 + 60)/10 = 66900
Average Rate of return ARR = average Income/intial investemnt
= 66900/400000 = 16.73%
Since Average Rate of return is less than required rate of return project is not accessable
sometime Average investment used in denominator
then
ARR = 66900/200000 = 33.45%
the project is acceptable
b)
NPV = -400000 + 65000/1.2 + 65000/1.2^2 + 68000/1.2^3 + 70000/1.2^4 + 65000/1.2^5 + 68000/1.2^6 + 70000/1.2^7 + 73000/1.2^8 + 65000/1.2^9 + 60000/1.2^10
= -119888.82
since NPV is negative project is not acceptable
c)
Profitibility index = PV of cash flows/intialinvetment
PV OF cash flows = 65000/1.2 + 65000/1.2^2 + 68000/1.2^3 + 70000/1.2^4 + 65000/1.2^5 + 68000/1.2^6 + 70000/1.2^7 + 73000/1.2^8 + 65000/1.2^9 + 60000/1.2^10
=280111.18
Profitability index PI = 280111.18/400000 = 0.7
since PI is less than 1 project os not acceptable
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