Medical Arts Hospital’s board of trustees is considering the addition of a comprehensive medical testing laboratory. In the past, the hospital has sent all blood and tissue specimens to Diagnostic Testing Services, an independent testing service. The hospital’s current contract with the testing service is due to expire, and the testing service has offered a new 10-year contract. Under the terms of the new contract, Medical Arts Hospital would pay Diagnostic Testing Services a flat fee of $80,000 per year plus $20 per specimen tested.

Since Medical Arts Hospital does not have its own comprehensive testing lab, the hospital staff is forced to refer some types of cases to a nearby metropolitan hospital. If Medical Arts Hospital had its own lab, these cases could be handled in-house. Medical Arts Hospital’s administrator estimates that the hospital loses $100,000 per year in contribution margin on the cases that currently must be referred elsewhere.

The proposed new lab would not require construction of a new building, since it would occupy space currently used by the hospital for storage. However, the hospital then would be forced to rent storage space in a nearby medical building at a cost of $30,000 per year. The equipment for the lab would cost $625,000 initially. Additional equipment costing $300,000 would be purchased after four years.

Due to the rapid technological improvement of medical testing equipment, the equipment would have negligible salvage value after 10 years. Staffing the lab would require two supervisors and four technicians. Annual compensation costs would run $40,000 each for the supervisors and $30,000 each for the lab technicians. Fixed operating costs in the lab would be $50,000 per year, and variable costs would amount to $10 per medical test.

Medical Arts Hospital requires 20,000 tests per year. The capacity of the lab would be 25,000 tests per year. Medical Arts Hospital’s administrator believes that physicians in private practice would utilize the lab’s excess capacity by sending their own tests to Medical Arts Hospital. The administrator has projected a charge of $20 per test for physicians in private practice. Medical Arts Hospital’s hurdle rate is 12 percent.

Required:

Use the total-cost approach to prepare a net-present-value analysis of the proposed testing laboratory.