Reference no: EM132682821
Question - Sturgis Medical Clinic (SMC) in Sturgis, SD is considering investing in new medical equipment that would increase its capacity to provide added services to treat patients. The machine will have a 5 year expected life. The projected cash flows related to this investment are as follows.
Investment in new medical equipment $500,000
Shipping cost for new equipment $10,000
Installation of new medical equipment 25,000
Travel and training for staff 55,000
Added customer accounts receivable 50,000
Power upgrade to handle new equipment 10,000
The projected incremental annual income statement items related to the services to be provided by the new machine appear below:
Added billed revenue: $650,000
Expected uncollectibles and insurance adjustments 55,000
Cash expenses 345,000
Depreciation (Straight line is used on the books) 100,000
Income before income taxes 150,000
Sturgis corporate income tax rate is 40%.
Sturgis uses MACRS depreciation on their tax return. The MACRS 5 year depreciation percentages using the ½ year rule are Year1 20% Year 2 32% Year 3 19.2% Year 4 11.52% Year 5 11.52%.
SMC has an after-tax minimum required return on investments of 12%.
At the end of 5 years SMC expects they could remove and sell the medical equipment to a smaller medical center for a net (after costs of removal) cash payment of $100,000. SMC also expects to recover the added working capital (customer accounts receivable) associated with this project.
Required -
1) Calculate the Profitability Index of this investment.
2) Calculate the Internal Rate of Return (IRR) for this investment.
3) Based upon your calculations should SMC make this investment? Justify your answer.
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