California Health Center is a for-profit hospital. It is evaluating the purchase of new diagnostic equipment. The equipment, which costs $600,000, has an expected life of 5 years, and an estimated pre-tax salvage value of $200,000 at that time. The equipment falls into the MACRS 5-year class for depreciation.

The equipment is expected to be used 15 times per day for 250 days per year for each year of the projects life. On average, each procedure is expected to generate $80 in payments, which is net of bad debt losses and contractual allowances, in its first year of use.

Labor and maintenance costs are expected to be $100,000 during the first year of operation, while utilities will cost another $10,000 and cash overhead will increase by $5,000 in year 1. The cost for expendable supplies is expected to average $5 per procedure during the first year.

All costs and revenues (except depreciation) are expected to increase at a 5% inflation rate after the first year. The hospitals tax rate is 30%, and its corporate cost of capital is 10%.

Based on this information, answer the questions below.

2. What are the net cash flows for each year (years 0 through 5)?

3. What is the net present value for these cash flows?

4. Conduct a sensitivity analysis using number of procedures per day, payment per procedure, and salvage value and change percentages of -30%, -20%, -10%, 0%, 10%, 20%, and 30%. Which variable(s) are the riskiest? Why?

5. Conduct a scenario analysis using the following scenarios. What is the expected NPV, standard deviation of the NPV, and the NPV coefficient of variation?

Probability	Procedures	Payment	Salvage Value
0.25	10	$60	$100,000
0.50	15	$80	$200,000
0.25	20	$100	$300,000

6. Assume the organization has a coefficient of variation of NPV in the range of 1.0 to 2.0. What level of risk (low, average, or high) is this project? Why?

7. Based on the level of risk, the organization adds 3% to the corporate cost of capital for high-risk projects and subtracts 3% to the corporate cost of capital for low-risk projects. Based on your previous answer, what is the projects cost of capital?

8. Adjust the analysis to account for the projects cost of capital. Does the project remain profitable? Why or why not? (Note: In doing this analysis, you can copy a worksheet already completed and then modify the projects cost of capital.)