Question

LGH, a non-taxpaying entity, is planning to purchase imaging equipment, including an MRI and ultrasonograms for its new imagining center. The equipment will generate $2,500,000 per year in revenues for the next five years. The expected operating expenses, excluding $800,000 in depreciation, will increase expenses by $950,000 per year for the next five years. The initial capital investment outlay for the imaging equipment is $4,500,000. The salvage value at year five is $500,000. The cost of capital is 9%. Compute the NPV. The answers are presented in $000's.

a. $1,854 b. $4,500 c. $6,354 d. None of the above

*explanation throughout solving would be really helpful*

Answer 1

Solution

Answer-1854

INITIAL INVESTMENT=4500000

Since it is a non tax paying entity the depreciation becomes redundand for calculation of NPV

Net cash inflow per year=Revenue generated-Expenses=2500000-950000=1550000

Now NPV=Present value of cash inflows-Initial investment

NPV=Present value of cash inflows from operations+Present value of salvage-Initial investment

Present value of a cashflow=Cashflow/(1+r)^n

where r=rate of discounting=cost of capital=9%

n=period of cashflow

NPV=1550000/(1+.09)^1+1550000/(1+.09)^2+1550000/(1+.09)^3+1550000/(1+.09)^4+1550000/(1+.09)^5+500000/(1+.09)^5-4500000

=1853925.151

Thus NPV=1854 (In thousands)

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