Dr. Helen Floss is the managing partner of the Crestwood Dental Clinic. Floss is trying to determine whether the clinic should move patient files and other items out of a spare room in the clinic and use the room for dental work. She has determined that it would require an investment of $358,950 for equipment and related costs to prepare the room for use. On the basis of receipts being generated from other rooms in the clinic, Floss estimates that the new room would generate a net cash inflow of $87,500 per year. The equipment purchased for the room would have a seven-year estimated useful life.

Required:

(Ignore income taxes.)

1. Compute the IRR on the equipment for the new room to the nearest whole percent. Verify your answer by computing the NPV of the equipment using the IRR you have computed as the discount rate.

2. Although seven years is the average life for dental equipment, Floss knows that due to changing technology, this life can vary substantially. Compute the IRR to the nearest whole percent if the life of the equipment is (a) five years and (b) nine years, rather than seven years. Is there any information provided by these computations that you would be particularly anxious to show Floss?

3. Refer to the original data. Assume that the equipment is purchased and that the room is opened for dental use. However, due to an increasing number of dentists in the area, the clinic is able to generate only $60,000 per year in net cash receipts from the new room. At the end of five years, the clinic closes the room and sells the equipment to a newly licensed dentist for a cash price of $101,375. Compute the IRR (to the nearest whole percent) that the clinic earned on its investment over the five-year period. Round all dollar amounts to the nearest whole dollar.