Replacement Decision, Computing After-Tax Cash Flows, Basic NPV Analysis

Okmulgee Hospital (a large metropolitan for-profit hospital) is considering replacing its MRI equipment with a new model manufactured by a different company. The old MRI equipment was acquired three years ago, has a remaining life of five years, and will have a salvage value of $100,000. The book value is $2,000,000. Straight-line depreciation with a half-year convention is being used for tax purposes. The cash operating costs of the existing MRI equipment total $1,000,000 per year.

The new MRI equipment has an initial cost of $5,000,000 and will have cash operating costs of $500,000 per year. The new MRI will have a life of five years and a salvage value of $1,000,000 at the end of the fifth year. MACRS depreciation will be used for tax purposes. If the new MRI equipment is purchased, the old one will be sold for $500,000. The company needs to decide whether to keep the old MRI equipment or buy the new one. The cost of capital is 12 percent. The combined federal and state tax rate is 40 percent.

You must use the Exhibit 19B.1 and Exhibit 19B.2 present value tables and Exhibit 19.5 to solve the following problem.

Required:

Compute the NPV of each alternative. When required, round your computations and final answers to the nearest dollar. If the NPV is negative, enter your answer as a negative value.

Old MRI equipment	$
New MRI equipment	$