To cope with the pressures of the recent pandemic, AC Milan Hospital has recently decided to expand its X-ray and Diagnosis-by-imaging department. This will allow them to diagnose Covid-19 patients more promptly, as well as decrease the backlog of patients on the waiting list because of other pathologies. As part of the growth plan, the Hospital Board has asked the department director, Dr. Kessie, to invest in new machinery while also preserving the overall equilibrium and financial health of the department. Dr. Kessie has repeatedly pointed out to the Board that his medical training did not train him to take financial and investment decisions, and, in utter distress, he has contacted you to support him in this decision. Dr. Kessie is aware of the ever-increasing financial pressures on the Hospital but is also concerned with the continued delivery of the best possible service to as many patients as possible. The first decision Dr. Kessie will have to make relates to a new CT Scan machine. The CT Scan machine currently in operation will be retained, but it is too slow and inefficient to cover the increasing demand. After some market research, two competing machine alternatives have been proposed to AC Milan Hospital: Quick and Easy CT Scan, a traditional scan machine, requiring an investment of 150,000, or Full Precision CT Scan, a new and more efficient machine that would allow quicker scans on a higher number of patients, requires an investment of 180,000. For each machine, revenues are represented by private customers' fees or NHS transfers. Revenues and costs for each project are shown below: Quick and Easy CT Scan Years 1 2 3 4 Revenues 1,000,000 800,000 600,000 400,000 Variable costs 500,000 400,000 300,000 200,000 Fixed costs 30,000 30,000 40,000 45,000 Full Precision CT Scan 1 2 3 4 Years Revenues 1,290,000 1,075,000 1,075,000 860,000 Variable costs 900,000 750,000 750,000 600,000 Fixed costs 25,000 30,000 30,000 70,000 AC Milan Hospital estimates that, at the end of the fourth year, Quick and Easy CT Scan will have a salvage value of 50,000, while Full Precision CT Scan will have a salvage value of 60,000. Both machines would be depreciated using straight-line depreciation. Dr. Kessie has been advised that both investments should be considered at a discount rate of 5%. Required: a) Compute the net present value (NPV) for both Quick and Easy CT Scan and Full Precision CT Scan. Based on the NPV figures only, which investment should be chosen and why? (10 marks) b) Compute the accounting rate of return (ARR) for both Quick and Easy CT Scan and Full Precision CT Scan. Relying on the ARR figures, which investment should be chosen and why? (6 marks) c) Prepare a memorandum to Dr. Kessie clearly stating your recommendation on the choice of the scan machine. In the memo, you should include comparisons and supporting calculations and briefly discuss your suggestions and reasons behind them. (4 marks) d) Discuss the main advantages and disadvantages of the ARR, the payback period and the NPV. (10 marks)
