Problem 1. Diagnostic Imaging The management of Diagnostic Imaging (DI) is considering opening five offices to perform CAT scans for rural North Carolinians, an underserved population. Di expects to able to buy the productive assets for this project and start generating revenues within three months of accepting the project. Di is analyzing the project over a 5-year horizon using a discount rate of 8% per year. Dl's marginal tax rate is 30%. Al project start (year 0) DI will buy office five buildings in rural locations in North Carolina for $2.5m. DI will depreciate the buildings to zero over 25 years using straight-line depreciation. Di expects the buildings to have a total market value of $2.4m at the end of year 5. Once Dl purchases the buildings it will spend a total of $1.5m to buy imaging equipment and install it. This equipment falls into the 5-year MACRS life class. The (rounded) depreciation percentages are: year 1, 20%. year 2, 30%; year 3, 20%. year 4,12%; year 5. 12%: year 6.5%. Management expects the imaging equipment lo have a market value of $0.5m at the end of year 5. At the same time it purchases the imaging equipment DI will spend another $0.5m on ancillary equipment Like the imaging equipment, the ancillary equipment falls into the 5-year MACRS life class. Di expects the ancillary equipment to have zero market value at the end of year 5. DI predicts revenues as follows: year 1, $9m, year 2, $12m; year 3. $13.2m; year 4, $14,5m; year 5, $16m. DI predicts direct costs to total 85% of sales. Simultaneously with purchasing the equipment management will spend $0.3825m on net working capital (NWC), mainly medical supplies. This is 5% of coming-year direct production costs. At the end of each subsequent year NWC must be 5% of coming-yoar direct production costs. DI oxpects the investment in NWC to be recaptured at the end of the project's life Should I open the office? Compute free cash flow each year in the project's life, then compute the project's nel present value (NPV). Intamal rate of rotum (IRR) and profitability Index (PI). Should DI accept the project by tho NPV, IRR and Pirulos? Team 0 3 4 0 2 3 4 1 Diagnostic Imaging 2 3 Year 4 Data 5 6 MACRS Dep. % - Imaging Equipment 7 MACRS Dep. % - Ancillary Equipment 8 9 Year 10 Pro Forma Income Statement (S mil) 11 12 Sales 13 - Direct Costs (excl. Depreciation) 14 - Depreciation - Imaging Equipment 15 - Depreciation -- Ancillary Equipment 16 - Depreciation -- Building 17 EBIT 18 - Tax (30%) 19 - Net Income 20 21 Year 22 Pro Forma Balance Sheet --Asset side (S mil) 23 24 Net Working Capital 25 Net Fixed Assets 26 Imaging Equipment 27 Ancillary Equipment 28 Building 0 3 4 20 Year MV BV T ATCF 0 1 2 3 4 Memo: After-tax Cash Flow - MV-(MV-BV)T 1 2 3 Imaging Equipment 4 Ancillary Equipment 5 Building 6 7 8 Year 9 Project Free Cash Flow (5 mil) 0 1 2 3 4 5 Net Cap Spending - Imaging Equip 6 Net Cap Spending -- Ancillary Equip -7-Net Cap Spending - Building B After-tax Project Free Cash Flow -9 60 NPV @ 8% $1 IRR 32 PI @ 8% 53 54
