Capital Budgeting

Sturgis Medical Clinic (SMC) in Sturgis, SD is considering investing in new medical equipment that would increase its capacity to provide added services to treat patients. The machine will have a 5 year expected life. The projected annual cash flows related to this investment are as follows.

Investment in new medical equipment - $ 500,000 Shipping cost for new equipment - $10,000 Installation of new medical equipment - 25,000 Travel and training for staff - 55,000 Added customer accounts receivable - 50,000 Power upgrade to handle new equipment - 10,000

The projected incremental annual income statement related to the services to be provided by the new machine appear below:

Added billed revenue: - $650,000 Expected uncollectibles and insurance adjustments - 55,000 Cash expenses - 345,000 Depreciation (Straight line is used on the books) - 100,000 Income before income taxes - 150,000 Sturgis corporate income tax rate is 40%.

SturgisusesMACRSdepreciationontheirtaxreturn. TheMACRS5yeardepreciation percentages using the 12 year rule are Year1 20% Year 2 32% Year 3 19.2% Year 4 11.52% Year 5 11.52%.

SMC has an after-tax minimum required return on investments of 12%.

At the end of 5 years SMC expects they could remove and sell the medical equipment to a smaller medical center for a net (after costs of removal) cash payment of $100,000. SMC also expects to recover the added working capital (customer accounts receivable) associated with this project.

Required (show your calculations):

a) Calculate the annual after-tax cash flow for each year that would result from acquiring the medical equipment.

b) Calculate the Accounting Rate of Return for each year and the five year average (ARR).

c) Calculate the Payback Period for the investment in years and months.

d) Calculate the Net Present Value (NPV) of this investment.

e) Calculate the Profitability Index of this investment.

f) Calculate the Internal Rate of Return (IRR) for this investment.

g) Based upon your calculations should SMC make this investment?

h) Justify your answer in g above.