Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 45

Interpretation of present value analysis—calculate annual cash flow Lake Regional Hospital is considering the acquisition of a new diagnostic scanning machine. The investment required to get the machine operational will be $2,082,560. The machine will be capable of performing 6,000 scanning procedures per year, but based on the experience of other hospitals, management estimates that the machine will be used at 80% of its capacity. The hospital’s cost of capital is 8%; the machine has an estimated useful life of seven years and no salvage value.

Required:

a. Assuming a constant cash flow every year, calculate the annual net cash flow required from the scanner if the IRR of the investment is to equal 8%. (Hint: The annual net cash flow requirement is an annuity.)

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b. If the direct cash costs of operating the scanner equal 50% of the annual net cash flow requirement calculated in part a, what price should the hospital charge per scanning procedure in order to achieve an 8% ROI?

Step 1 of 4

Present value analysis : It is a technique of evaluating the value of money currently with the value of money in a specified future date.

Internal rate of return (IRR ): It refers to the interest rate that makes the summation of all cash inflows and outflows zero and is helpful to compare an investment to another.

ROI: It stands for return on investment. It is a performance measure that is used to estimate the efficiency of a particular investment return.