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Question - Wally loves the advice you have been giving him! He is now determining if he should invest in opening a new private medical imaging clinic to cater to the growing demand for diagnostic medical images; the aging population means more and more people need to get these tests. To start the clinic, Wally thinks he will need to immediately invest in $20,000 of equipment and one MRI machine costing $2.4M. Both assets depreciate at a rate of 30%. Assume that the MRI machine will be sold for $1.4M when the business is closed (in two years). The computer equipment will be worthless at that time. The clinic will charge $600 per scan and the company expects to do 3,800 scans in the first year and 4,100 in the second year. Operating cash flows as a percentage of sales are expected to be 49.12% in the first year and 49.59% in the second year. Assume that all revenues (and expenses) occur at the end of the year. The tax rate is 40% and OllieCorp's cost of capital is 10%.
(a) Should Wally invest in the medical imaging clinic? Why? Please base your answer on your estimate of the NPV of the investment. Please provide a clear concluding statement that summarizes your result.
(b) Wally has heard about something called the Internal Rate of Return (IRR). He wants to know if the IRR for this project is greater than, less than or equal to 10% for this project? How do you know?
(c) Wally wonders, if OllieCorp's cost of capital was 5% instead of 10%, should he invest? Why or why not?
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