California Health Center, a for profit hospital

| November 9, 2018

California Health Center, a for profit hospital, is evaluating the purchase of a new diagnostic equipment. The equipment, which costs $600,000, has an expected life of five years and an estimated pretax salvage of $200,000 at 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 loses and contractual allowances,in its first year of use. Thus,net revenues for year 1 are estimated at 15x 250x$80=$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 5% inflation rate after the first year.The equipment falls into the MACRS five-year class f,or tax depreciation and is subject to the following depreciation allowances:year Allowances1 0.202 0.323 0.194 0.125 0.116 0.06 1.00The hospital’s tax rate is 40% and its corporate cost of capital is 10%a. Estimate the project’s net cash flows over its five-year estimated life(hint:use the following format as a guide) 0 1 2 3 4 5Equipment costNet revenuesless: labor/ maintenance costsUtilities costsSuppliesIncremental overheadDepreciationopening incomeTaxesNet operating incomePlus: DepreciationPlus: Equipment salvage valueNet cash flowb. What are the project’s NPV and IRR? (Assume for now that the project has average risk)

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