A hospital is considering the purchase of a piece of medical equipment that cost

Question

A hospital is considering the purchase of a piece of medical equipment that costs $1,000,000 and has a useful life of five years and no salvage value at the end of its useful life. The equipment generates revenues of $450,000 per year and operating expenses of $200,000. Should the equipment be purchased if the discount rate is 4%?

                                    Revenue           Expense

            Year 0                      -               $1,000,000 (investment)

            Year 1               $450,000           $200,000

            Year 2               $450,000           $200,000

            Year 3               $450,000           $200,000

            Year 4               $450,000           $200,000

            Year 5               $450,000           $200,000

          NPV:    ________          BCR: ________            IRR: ________ Payback: ________

2.         Assume the discount rate increases to 6%, should the equipment be purchased?

NPV:    ________          BCR: ________            IRR: ________ Payback: ________

3.         Assume revenues decrease and expenses increase with the age of the machine, as given in the table below, should the equipment be purchased if the discount rate is 6%?

                                    Revenue           Expense

            Year 0                      -               $1,000,000 (investment)

            Year 1               $500,000           $150,000

            Year 2               $450,000           $175,000

            Year 3               $400,000           $200,000

            Year 4               $350,000           $225,000

            Year 5               $300,000           $250,000

            NPV:    ________          BCR: ________            IRR: ________ Payback: ________

Explanation / Answer

The initial cost of machinery is 1000,000 and it will be depreciated to zero salvage value in 5 years
Thus depreciation = 1000,000 / 5 = 200,000 each year

Also After tax Operating Cash flow = (sales-cost-depreciation)*(1-tax)+depreciation
here tax is not given thus we assume it as zero

Answer 1. Discount rate 4%

Years

Revenues

Cost

Depreciation

After Tax operating cashflow = (sales-cost-depreciation)*(1-tax)+depreciation

Cumulative Cashflow = Cumulative cashflow of previous year + Cashflow of current year

Discounted Cashflow = After tax operating Cashflow / 1+0.04^n

0

0

-1000000

0

-1000000

-1000000

-1000000

1

450000

200000

200000

250000

-750000

260000

2

450000

200000

200000

250000

-500000

270400

3

450000

200000

200000

250000

-250000

281216

4

450000

200000

200000

250000

0

292465

5

450000

200000

200000

250000

250000

304163

NPV at 4%

$108,611.14

BCR = cashoutflow / sum of positive discounted cashflows

0.710

IRR

7.931%

Payback period = 3+(250000-0)/250000

4

NPV: $108,611.14      BCR: 0.710     IRR: 7.931% Payback: 4 years
As the projects NPV is positive, the equipment should be purchased.



Answer 2. Discount rate increases to 6%

Years

Revenues

Cost

Depreciation

After Tax operating cashflow = (sales-cost-depreciation)*(1-tax)+depreciation

Cumulative Cashflow = Cumulative cashflow of previous year + Cashflow of current year

Discounted Cashflow = After tax operating Cashflow / 1+0.06^n

0

0

-1000000

0

-1000000

-1000000

-1000000

1

450000

200000

200000

250000

-750000

265000

2

450000

200000

200000

250000

-500000

280900

3

450000

200000

200000

250000

-250000

297754

4

450000

200000

200000

250000

0

315619

5

450000

200000

200000

250000

250000

334556

NPV at 6%

$50,085.80

BCR = cashoutflow / sum of positive discounted cashflows

0.669

IRR

7.931%

Payback period = 3+(250000-0)/250000

4

NPV: $50,085.80 BCR: 0.669 IRR: 7.931% Payback: 4 years
As the projects NPV is positive, the equipment should be purchased.


Answer 3. Discount rate of 6% with revenues decreased and expenses increased.

Years

Revenues

Cost

Depreciation

After Tax operating cashflow = (sales-cost-depreciation)*(1-tax)+depreciation

Cumulative Cashflow = Cumulative cashflow of previous year + Cashflow of current year

Discounted Cashflow = After tax operating Cashflow / 1+0.06^n

0

0

-1000000

0

-1000000

-1000000

-1000000

1

500000

150000

200000

350000

-650000

371000

2

450000

175000

200000

275000

-375000

308990

3

400000

200000

200000

200000

-175000

238203

4

350000

225000

200000

125000

-50000

157810

5

300000

250000

200000

50000

0

66911

NPV at 6%

-$113,928.14

BCR = cashoutflow / sum of positive discounted cashflows

0.875

IRR

0.00%

Payback period = 4+(50000-0)/50000

5

NPV: -$113,928.14 BCR: 0.875 IRR: 0% Payback: 5 years
As the projects NPV is negative, the equipment shouldnt be purchased.

Years

Revenues

Cost

Depreciation

After Tax operating cashflow = (sales-cost-depreciation)*(1-tax)+depreciation

Cumulative Cashflow = Cumulative cashflow of previous year + Cashflow of current year

Discounted Cashflow = After tax operating Cashflow / 1+0.04^n

0

0

-1000000

0

-1000000

-1000000

-1000000

1

450000

200000

200000

250000

-750000

260000

2

450000

200000

200000

250000

-500000

270400

3

450000

200000

200000

250000

-250000

281216

4

450000

200000

200000

250000

0

292465

5

450000

200000

200000

250000

250000

304163

NPV at 4%

$108,611.14

BCR = cashoutflow / sum of positive discounted cashflows

0.710

IRR

7.931%

Payback period = 3+(250000-0)/250000

4

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.