Sturgis Medical Clinic (SMC) in Sturgis, SD is considering investing in new medical imaging equipment that would increase its capacity to provide added services to treat patients. The machine will have a 5 year expected life. The projected annual cash flows related to this investment are as follows:
Investment in new medical equipment $ 450,000
Shipping cost for new equipment $ 20,000
Installation of new medical equipment 25,000
Travel and training for staff 65,000
Added customer accounts receivable fully Recovered in year 5 is 60,000
Power upgrade to handle new equipment 15,000
The projected incremental annual income statement related to the services to be provided by the new machine appear below:
Added billed revenue: $600,000
Expected uncollectibles and insurance adjustments 65,000
Operating expenses (supplies, salaries and fringe, etc.) 335,000
Depreciation (Straight line is used on the books) 80,000
Expected salvage value after 5 years 50,000
Sturgis corporate income tax rate is 35%
Sturgis uses MACRS depreciation on their tax return. The MACRS 5 year depreciation percentages multiplied by the cost of the asset using the ½ year rule are:
Year 1 20% Year 2 32% Year 3 19.2% Year 4 11.52% Year 5 11.52%.
SMC has an after-tax minimum required return on investments of 10%. At the end of 5 years SMC expects they could remove and sell the medical equipment to a smaller medical center for a net (after costs of removal) cash payment of $75,000. SMC also expects to recover the added working capital (customer accounts receivable) associated with this project.
Required (show your calculations):
a) Calculate the annual after-tax cash flow for each of the 5 years that would result from acquiring the medical equipment.
b) Calculate the Accounting Rate of Return for each of the 5 years and the five year average (ARR).
c) Calculate the Payback Period for the investment in years and months.
d) Calculate the Net Present Value (NPV) of this investment.
e) Calculate the Profitability Index of this investment.
f) Calculate the Internal Rate of Return (IRR) for this investment.
g) Based upon your calculations should SMC make this investment?
h) Justify your answer in g above.
(Some explanation to how the numbers got there please)
a.
| Required return on Investments | 10% | ||||
| Cashoutflow | |||||
| Investment in Medical equipment | $ 4,50,000.00 | ||||
| Installation of New Medical equipment | $ 25,000.00 | ||||
| Shipping cost for new equipment | $ 20,000.00 | ||||
| Travel and Training for staff | $ 65,000.00 | ||||
| Power upgrade to handle new equipment | $ 15,000.00 | ||||
| Total cashoutflow | $ 5,75,000.00 | ||||
| Income Tax rate | 35% | ||||
| A/Cashinflow calculation | |||||
| Details | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Billed revenue | $ 6,00,000.00 | $ 6,00,000.00 | $ 6,00,000.00 | $ 6,00,000.00 | $ 6,00,000.00 |
| Uncollectibles and insurance | $ -65,000.00 | $ -65,000.00 | $ -65,000.00 | $ -65,000.00 | $ -65,000.00 |
| Operating Expenses | $ -3,35,000.00 | $ -3,35,000.00 | $ -3,35,000.00 | $-3,35,000.00 | $ -3,35,000.00 |
| Revenue before tax | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 |
| Deprication % | 20.00% | 32.00% | 19.20% | 11.52% | 11.52% |
| Deprication | $ 90,000.00 | $ 1,44,000.00 | $ 86,400.00 | $ 51,840.00 | $ 51,840.00 |
| Net income after deprication | $ 1,10,000.00 | $ 56,000.00 | $ 1,13,600.00 | $ 1,48,160.00 | $ 1,48,160.00 |
| Taxes | $ 38,500.00 | $ 19,600.00 | $ 39,760.00 | $ 51,856.00 | $ 51,856.00 |
| Net profit | $ 71,500.00 | $ 36,400.00 | $ 73,840.00 | $ 96,304.00 | $ 96,304.00 |
| Net cash inflow | $ 1,61,500.00 | $ 1,80,400.00 | $ 1,60,240.00 | $ 1,48,144.00 | $ 1,48,144.00 |
b.
| B/Calculation of accounting return | |||||
| Accounting return | |||||
| Details | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| Billed revenue | $ 6,00,000.00 | $ 6,00,000.00 | $ 6,00,000.00 | $ 6,00,000.00 | $ 6,00,000.00 |
| Uncollectibles and insurance | $ -65,000.00 | $ -65,000.00 | $ -65,000.00 | $ -65,000.00 | $ -65,000.00 |
| Operating Expenses | $ -3,35,000.00 | $ -3,35,000.00 | $ -3,35,000.00 | $-3,35,000.00 | $ -3,35,000.00 |
| Revenue before tax | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 | $ 2,00,000.00 |
| Deprication % | 20.00% | 32.00% | 19.20% | 11.52% | 11.52% |
| Deprication | $ 80,000.00 | $ 80,000.00 | $ 80,000.00 | $ 80,000.00 | $ 80,000.00 |
| Net income after deprication | $ 1,20,000.00 | $ 1,20,000.00 | $ 1,20,000.00 | $ 1,20,000.00 | $ 1,20,000.00 |
| Taxes | $ 38,500.00 | $ 19,600.00 | $ 39,760.00 | $ 51,856.00 | $ 51,856.00 |
| Net profit | $ 81,500.00 | $ 1,00,400.00 | $ 80,240.00 | $ 68,144.00 | $ 68,144.00 |
| Accoutning return (Net income / Total cash outflow) | 14% | 17% | 14% | 12% | 12% |
| Average cash inflow | $ 79,686.00 | ||||
| Average return | 14% |
c.