Due to rising utility costs, Eastern Community Hospital wants to replace its existing computer-controlled heating and cooling system (heating, ventilation, and air-conditioning [HVAC]) with a more efficient version. The existing system was purchased three years ago for $240,000 and is being depreciated on a straight-line basis over an eight-year life to zero salvage value. Although the current book value for the existing system is $150,000, this system could be sold for only $80,000 today. The new system would cost $500,000 and would be depreciated on a straight-line basis over a five-year life to a zero salvage value. The new heating and cooling system would reduce utility costs by $185,000 per year for five years and would not affect the level of net working capital. The economic life of the new system is five years, and the required rate of return on the project is 5 percent.
a. Should the existing HVAC system be replaced? Use the incremental NPV approach to evaluate the decision under a nonprofit assumption.
b. If the facility were a taxpaying entity with a tax rate of 40 percent, should the existing HVAC system be replaced? Use the incremental NPV approach to evaluate the decision. (Hint: see Appendix F.)
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