Question

Diemia Hospital has been considering the purchase of a new x-ray machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $170,000. The new machine will cost $700,000 and an additional cash investment in working capital of $115,000 will be required. The new machine will reduce the average amount of time required to take the x-rays and will allow an additional amount of business to be done at the hospital. The investment is expected to net $150,000 in additional cash inflows during the year of acquisition and $180,000 each additional year of use. The new machine has a three-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.
Required:
What is the net present value of the investment, assuming the required rate of return is 9%? Would the hospital want to purchase the new machine?

Answer 1

Answer:

1. Present value of cash-out flow = Purchase of new machine + Cost of working capital - Sale of old machine

Present value of cash-out flow = $700,000 + $115,000 - $170,000

Present value of cash-out flow = $645,000

Year   Cash flow   PVF 9%    Net cash flow

1          $150,000     0.917          $137,550

2         $180,000     0.842         $151,560

3         $180,000     0.772         $138,960

4         $180,000     0.708         $127,440

5         $180,000     0.65           $117,000

Present value of Cash inflow    $672,510

Present value of Cash outflow ($645,000)

Net present value                     $27,510

2. Yes, Hospital would want to purchase the new machine because the Net present value is positive.