Review of Basic Capital Budgeting Procedures

For discount factors use Exhibit 12B-1 and Exhibit 12B-2.

Dr. Whitley Avard, a plastic surgeon, had just returned from a conference in which she learned of a new surgical procedure for removing wrinkles around eyes, reducing the time to perform the normal procedure by 50%. Given her patient-load pressures, Dr. Avard is excited to try out the new technique. By decreasing the time spent on eye treatments or procedures, she can increase her total revenues by performing more services within a work period. In order to implement the new procedure, special equipment costing $74,000 is needed. The equipment has an expected life of 4 years, with a salvage value of $6,000. Dr. Avard estimates that her cash revenues will increase by the following amounts:

Year	Revenue Increases
1	$19,800
2	27,000
3	32,400
4	32,400

She also expects additional cash expenses amounting to $3,000 per year. The cost of capital is 12%. Assume that there are no income taxes.

Required:

1. Compute the payback period for the new equipment. Round your answer to two decimal places. years

2. Compute the ARR. Round your answer to two decimal places. %

3. CONCEPTUAL CONNECTION: Compute the NPV and IRR for the project. Use 14% as your first guess for IRR.

NPV	$
IRR		%

Should Dr. Avard purchase the new equipment?

4. CONCEPTUAL CONNECTION: Before finalizing her decision, Dr. Avard decided to call two plastic surgeons who have been using the new procedure for the past 6 months. The conversations revealed a somewhat less glowing report than she received at the conference. The new procedure reduced the time required by about 25% rather than the advertised 50%. Dr. Avard estimated that the net operating cash flows of the procedure would be cut by one-third because of the extra time and cost involved (salvage value would be unaffected). Using this information, recompute the NPV of the project. Round present value calculations and your final NPV answer to the nearest dollar. Use the minus sign to indicate a negative NPV. $

What would you now recommend?