Gapenski, Problem 15.3 - question is at bottom of post!!

(Provided for context only): California Health Center, a for-profit hospital, is evaluating the purchase of new diagnostic equipment. The equipment costs $600K & has a 5yr estimated life, and a $200K estimated pretax salvage value. The equipment is expected to be used 15x per day for 250 days each year of the project's life. Each procedure is expected to generate an avg of $80 in collections (net of bad debt losses and contractual allowances), in its first year of use. Net revenues for Year 1 are estimated at 15*250*$80 = $300K. Labor & maintenance are expected to be $100K during the first year of operation, utilities cost another $10K and cash overhead will increase by $5k in Year 1. Expendable supplies cost 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 equipment falls into the MACRS 5yr class for tax depreciation and is subject to the following depreciation allowances:

Year Allowances

1 0.20

2 0.32

3 0.19

4 0.12

5 0.11

6 0.06

1.00

The hospital's tax rate is 40% and its corporate cost of capital is 10%.

Attached pictures are project's net cash flows over 5yr estimated life, and project's NPV & IRR (assuming project has average risk)

Gapenski, Problem 15.3 (actual questions to be answered are below!!):

a. Perform a sensitivity analysis to see how NPV is affected by changes in the # of procedures per day, average collection amount, and salvage value.

b. Conduct a scenario analysis. Suppose the hospital's staff concluded the 3 most uncertain variables are # of procedures per day, avg collection amt, and equipment's salvage value. Furthermore, the following data were developed:

Scenario Probability # Procedures Avg Collection Amt Salvage Value

Worst 0.25 10 $60 $100,000

Most Likely 0.50 15 $80 $200,000

Best 0.25 20 $100 $300,000

c. Finally, assume CA Health Ctr's avg project has a coefficient of variation of NPV in the range of 1.0-2.0 (hint: coefficient of variation is standard deviation of NPV divided by expected NPV). The hospital adjusts for risk by adding or subtracting 3 percentage points to its 10% corporate cost of capital. After adjusting for the differential risk, is the project still profitable?

d. What type of risk was measured and accounted for in parts b and c? should this be of concern to the hospital's managers?