Garfield Medical System, a taxpaying entity, is considering a new orthopedic center.

The building and equipment for the new center will cost $7,500,000. The equipment and building will be depreciated on a straight-line basis over its five-year life to a $2,500,000 salvage value. The new orthopedic center’s projected net revenue and expenses are listed below. The project will be financed partially by debt capital. Interest expense is expected to be $600,000 per year, and principal payments on the bank loan are expected to be

$1,250,000 per year for the first five years of the loan. The new orthopedic center is expected to take away after-tax cash profits of $1,000,000 per year from inpatient orthopedic services. The tax rate for the institution is 40 percent, and its cost of capital is 10 percent. Two years ago, a $100,000 financial feasibility study was conducted and paid for.

Pro forma working capital projections are listed below. These are the permanent account balances for inventory, accounts receivable, and accounts payable. Use the NPV and IRR approaches to determine if this project should be undertaken. (Hint: see Appendices C and E.)

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Pro forma income statement accounts for the Orthopedic Center (in 000's) Years 0 1 2 3 4 5 Net revenues Operating expenses before dep. and int. $6,500 $9,500 $12,000 $14,000 $16,000 $6,000 $6,500 $7,000 $7,500 $8,500 Annual interest expense Annual depreciation expense $600 $600 $600 $600 $600 $1,000 $1,000 $1,000 $1,000 $1,000 Pro forma working capital accounts for the Orthopedic Center (in 000's) Working capital: inventory, A/R Working capital: accounts payable $2,500 $3,500 $700 $1,100 $1,600 $2,000 $1,400 $4,000 $3,000 $2,000