Suppose that a private hospital is pondering its next investment—the buying of costly medical equipment for $1 million. The new equipment should bring in real net profits of $150,000 per year. The real interest rate is 8% this year and expected to be constant; the depreciation rate is 10% for this kind of machinery.
a. Should the hospital make the investment? Compare the cost of the equipment and its expected profits.
b. Suppose that the rate of interest were to decrease permanently, due to an improvement of the general conditions of the economy, to 5%. How would that affect the hospital’s investment decision?