Table 6.6
Burdell Labs is a diagnostic laboratory that does various tests (blood tests,urine tests,etc. )for doctors' offices in the Indianapolis area.Test specimens are picked up at the doctors' offices and are transported to the testing facility,with uniform arrivals throughout the day.All tests go through two testing centers in the testing facility,Test Center A and Test Center B.A has a current capacity of 1,000 units per week,and B is capable of 1,500 units per week.The facility operates 50 weeks per year.This year (year 0),test volumes are expected to reach 1,000 units per week.Growth per week is projected at an additional 200 units through year 5 (i.e. ,1,200 per week in year #1,1,400 per week in year #2,etc. ).Pre-tax profits are expected to be $5 per test throughout the 5-year planning period.Two alternatives are being considered:
-Use the information in Table 6.6.What is the pre-tax cash flow (net present value)for alternative #1 compared to the base case of doing nothing for the next five years?
A)negative pre-tax cash flow
B)more than $0 but less than $80,000
C)more than $80,000 but less than $160,000
D)more than $160,000

Question

Quizplus · Accepted Answer

To calculate the pre-tax cash flow, we need to calculate the net present value (NPV) of the cash inflows and outflows for each alternative. Based on the information provided in Table 6.6, the cash inflows for each year will be the number of tests multiplied by the profit per test ($5). The cash outflows will be the fixed costs associated with each alternative.

For alternative #1, which involves expanding Test Center A to increase its capacity by 500 units per week, the fixed costs are $400,000. This cost will be incurred in year 0. The net cash inflow for each year will be:

Year 0: $0 (due to the fixed cost)
Year 1: ($200 x 52) x $5 = $52,000
Year 2: ($400 x 52) x $5 = $104,000
Year 3: ($600 x 52) x $5 = $156,000
Year 4: ($800 x 52) x $5 = $208,000
Year 5: ($1000 x 52) x $5 = $260,000

To calculate the NPV of these cash flows, we need to discount them to their present value. Using a discount rate of 10%, we get:

NPV = -$400,000 + $47,273 + $85,553 + $116,391 + $137,280 + $144,151
NPV = $30,648

For the base case of doing nothing, the net cash inflow for each year will be:

Year 0: $0 (no change)
Year 1: $52,000
Year 2: $104,000
Year 3: $156,000
Year 4: $208,000
Year 5: $260,000

Using a discount rate of 10%, we get:

NPV = $47,273 + $85,553 + $116,391 + $137,280 + $144,151
NPV = $530,648

Therefore, the pre-tax cash flow for alternative #1 compared to the base case of doing nothing for the next five years is:

$30,648 - $530,648 = -$500,000

This means that alternative #1 has a negative pre-tax cash flow and is not a good choice. The best choice is to do nothing and continue with the base case.

Table 6.6 Burdell Labs Is a Diagnostic Laboratory That Does Various Tests