Because of its inability to control film and personnel costs in its radiology department, Sanger General Hospital wants to replace its existing picture archive and communication

(PAC) system with a newer version. The existing system, which has a current book value of $2,250,000, was purchased three years ago for $3,600,000 and is being depreciated on a straight-line basis over an eight-year life to a salvage value of $0. This system could be sold for $800,000 today. The new PAC system would reduce the need for staff by eight people per year for five years at a savings of $40,000 per person per year, and it would reduce film costs by $2,000,000 per year. The project would not affect the level of net working capital. The new PAC system would cost $9,000,000 and would be depreciated on a straight-line basis over a five-year life to a salvage value of $0. The economic life of the new system is five years, and the required rate of return on the project is 7 percent.

a. Should the existing PAC system be replaced? Use the incremental NPV approach to evaluate the decision; assume the hospital is a not-for-profit facility.

b. If the facility were a taxpaying entity with a tax rate of 30 percent, should the existing PAC system be replaced? Use the incremental NPV approach to evaluate the decision.

(Hint: see Appendix F.)