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Hospital tax rates

California Health Center, a for-profit hospital, is evaluating the purchase of new diagnostic equipment.

The equipment, which costs $600,000, has an expected life of five years and an estimated pretax salvage

value of $200,000 at that time. The equipment is expected to be used 15 times a day for 250 days a year

for each year of the project?s life. On average, each procedure is expected to generate $80 in collections,

which is net of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for

Year 1 are estimated at 15 X 250 X $80 = $300,000.

Labor and maintenance costs are expected to be $100,000 during the first year of operation, while utilities

will cost another $10,000 and cash overhead will increase by $5,000 in Year 1. The cost for expendable

supplies is expected to average $5 per procedure during the first year. All costs and revenues, except

depreciation, are expected to increase at a 5 percent inflation rate after the first year.

The equipment falls into the MACRS five-year class for tax depreciation and hence is subject to the

following depreciation allowances:
Year Allowance
1
0.2
2 0.32
3 0.19
4 0.12
5 0.11
6 0.06

The hospital?s tax rate is 40 percent, and its corporate cost of capital is 10 percent.

a. Estimate the project?s net cash flows over its five-year estimated life.

b. What are the project?s NPV and IRR? (Assume that the project has average risk.)

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