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14.7 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 five years and an estimated pretax salvage value 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 projects 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 15 250 $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 proce- dure during the first year. All costs and revenues, except deprecia- tion, are expected to increase at a 5 percent inflation rate after the first year.

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e equipment falls into the MACRS five-year class for tax depreciation and is subject to the following depreciation allowances:

Year Allowance

1 0.20 2 0.32 3 0.19 4 0.12 5 0.11 6 0.06

1.00

The hospitals tax rate is 40 percent, and its corporate cost of capi- tal is 10 percent.

a. Estimate the projects net cash flows over its five-year estimated life. (Hint: Use the following format as a guide.)

Year

012345

Equipment cost Net revenues Less: Labor/maintenance costs

Utilities costs Supplies Incremental overhead Depreciation

Operating income Taxes

Net operating income Plus: Depreciation Plus: Equipment salvage value

Net cash flow

b. What are the projects NPV and IRR? (Assume for now that the project has average risk.)

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