Capital Budgeting

California Health Center, a for-profit hospital, is evaluating the purchase of a new diagnostic equipment, which costs $600,000 and has an expected life of five years. Average investments in inventory and accounts receivable will be $50,000 and $200,000 respectively, while the average accounts payable balance will be $30,000. The expected before-tax salvage value of the equipment after five years use is $200,000. The equipment will produce an annual revenue of $300,000 each year in years 1-3, and $350,000 in years 4 and 5.

All costs excluding depreciation: 22% of revenue

Depreciation method: MACRS

Year Depreciation

1 20%

2 32%

3 19%

4 12%

5 11%

6 6%

You will multiply the depreciation percentage for each year by the purchase price to get the depreciation expense in dollars for that year.

Tax rate: 21%

Estimate the projects cash flows for the next five years and calculate the projects payback period, NPV and IRR. The cost of capital is 11% and the required payback is three years. Indicate whether the project will be acceptable by each of the three techniques.