Reference no: EM132467211

A government data processing center has been plagued in recent years by complaints from employees of back pain. Consultants have estimated that upgrading office furniture at a current cost of $600,000 would reduce the incidence and severity of back injuries each year, allowing the center to avoid medical care that currently costs $85,000 (thus a benefit if the investment is made). They estimate that the new furniture would also provide yearly benefits of avoided losses in work time and employee comfort worth $60,000, but these benefits decline 6% per year as the furniture wears. The decline begins in year 2, the first year of use. All three values reported so far are in real terms. The furniture would have a useful life of six years, after which it would have a positive salvage value equal to 15% of its initial net cost (real). Assume the furniture is purchased at the end of year 1, and the benefits occur at the end of years 2-7.

In its investment decisions, the center uses a real discount rate of 10% and an assumed general inflation rate of 2%. It expects the inflation rate for medical care to be 8% (nominal) and uses that rate for medical care, but is uncertain as to the exact rate. Avoided losses in work time, etc. grow at the general inflation rate. Should the center purchase the new furniture? Do the analysis both in real and nominal terms. Calculate the NPV, IRR, and B/C. Also, calculate the breakeven rate of medical inflation.

You can use excel for this calculation.