Dr. Claudia Gomez, a plastic surgeon, had just returned from a conference in which she learned of a new surgical procedure for removing wrinkles around eyes, reducing the time to perform the normal procedure by 50%. Given her patient-load pressures, Dr. Gomez is excited to try out the new technique. By decreasing the time spent on eye treatments or procedures, she can increase her total revenues by performing more services within a work period. In order to implement the new procedure, special equipment costing $88,800 is needed. The equipment has an expected life of 4 years, with a salvage value of $7,200. Dr. Gomez estimates that her cash revenues will increase by the following amounts:

She also expects additional cash expenses amounting to $3,600 per year. The cost of capital is 12%. Assume that there are no income taxes.

Required:
1. Compute the payback period for the new equipment.
2. Compute the ARR. Round the percentage to two decimal places.
3. Compute the NPV and IRR for the project. Use 14% as your first guess for IRR. Should Dr. Gomez purchase the new equipment? Should she be concerned about payback or the ARR in making this decision?
4. Before finalizing her decision, Dr. Gomez decided to call two plastic surgeons who have been using the new procedure for the past 6 months. The conversations revealed a somewhat less glowing report than she received at the conference. The new procedure reduced the time required by about 25% rather than the advertised 50%. Dr. Gomez estimated that the net operating cash flows of the procedure would be cut by one-third because of the extra time and cost involved (salvage value would be unaffected). Using this information, recompute the NPV of the project. What would you now recommend? When calculating the new cash flows, round the reduction factor to five decimal places.

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Year 1 2 3 4 Revenue Increases $23,760 32,400 38,880 38,880