Sultan’s Hospital is a private hospital providing a range of care to patients. It is currently appraising a major capital investment project. The hospital directors are considering opening up a specialist fertility department in a wing of the hospital that is currently unused. If the decision is made to proceed with the investment, the equipment would be bought and the staff would be recruited immediately. Treatment and testing of patients could then start straight away.

In assessing the viability of capital projects, the hospital currently uses a target accounting rate of return of 20% (based on the average investment over the period) and a target payback period of four years. It will undertake a project only if BOTH the accounting rate of return and the payback period meet or exceed the targets. The following data are available for this proposed investment.

OMR’000

Cost of specialist equipment ???

Annual increased revenues 5,000

Annual increased staff costs (1,500)

Annual increased other costs* (1,000)

* No depreciation is included in these figures.

After five years, it is thought that most of the equipment would have become outdated and would have a residual value of only OMR 0.5 million.

The company’s cost of capital is 10% per annum.

Required

Calculate the accounting rate of return and the payback period for the project and recommend on a purely financial basis whether the project should proceed.