A hospital is considering to purchase a diagnostic machine costing Rs. 80,000. The projected life of the machine is 8 years and has an expected salvage value of Rs. 6,000 at the end of 8 years. The annual operating cost of the machine is Rs. 7,500. It is expected to generate revenues of Rs. 40,000 per year for eight years. Presently, the hospital is outsourcing the diagnostic work and is earning commission income of Rs.12,000 per annum; net of taxes.
Required:
Whether it would be profitable for the hospital to purchase the machine? Give your recommendation under:
(i) Net Present Value method
(ii) Profitability Index method.
PV factors at 10% are given below:
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467
Hint: 1. Advise to the Hospital Management, Determination of Cash inflows
Sales Revenue 40,000
Less: Operating Cost 7,500 = 32,500
Less: Depreciation (80,000 – 6,000)/8 9,250
Net Income 23,250, Tax @ 30% = 6,975
Earnings after Tax (EAT) 16,275
Add: Depreciation 9,250
Cash inflow after tax per annum 25,525
Less: Loss of Commission Income 12,000
Net Cash inflow after tax per annum 13,525
In 8th Year :
New Cash inflow after tax 13,525
Add: Salvage Value of Machine 6,000
Net Cash inflow in year 8 19,525
2. Calculation of Net Present Value (NPV), hope you can do
3. GIve Advise:( Since the net present value is negative and profitability index is also less than 1, therefore, the hospital should not purchase the diagnostic machine. Note: Since the tax rate is not mentioned in the question, therefore, it is assumed to be 30 percent in the given solution.)
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