California Health Center, a for profit hospital, is evaluating the purchase of new diagnostic equipment. The equipment, which costs $600,000, has an expected life of 5 years and an estimated pretax salvage value of $200,000at that time. The equipment is expected to be used 15 times a day for 250 days a year for each year of the project's life. On average, each procedure is expected to generate $80 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 15X250X80=$300,000. Labor and maintenance costs are expected to be $100,000 during the first year of operation, while utilities will cost another $10,000 and cash overhead will increase by $5,000 in year 1. The cost for expendable supplies is expected to average $5 per procedure during the first year. All costs and revenues, except depreciation, are expected to increase at a 5 percent inflation rate after the first year.
The equipment falls into the MACRS five-year class for tax depreciation and hence is subject to following deprecation allowance;
Year Allowance
1 0.20
2 0.32
3 0.19
4 0.12
5 0.11
6 0.06
1 .00
The hospital's tax rate is 40%, and its corporate cost of capital is 10%
1. Estimate the project's net cash flows over its five-year estimated life.
2. What are the project's NPV and IRR?
3. Assume the project is assessed to have high risk and California Imaging Center adds or subtracts 3 percentage points to adjust for project risk. Now, what is the project's NPV? Does the risk assessment change how the project's IRR is interpreted?