Colorado Clinic is considering investing in new heart-monitoring equipment.

It has two options: Option A would have an initial lower cost but would require a significant expenditure for rebuilding after 4 years. Option B would require no rebuilding expenditure, but its maintenance costs would be higher. Since the option B machine is of initial higher quality, it is expected to have a salvage value at the end of its useful life. The following estimates were made of the cash flows. The company’s cost of capital is 8%.

Instructions

(a) Compute the (1) net present value and (2) internal rate of return for each option.
(Hint: To solve for internal rate of return, experiment with alternative discount rates to arrive at a net present value of zero.)

(b) Which option should be accepted?

Transcribed Image Text:

Initial cost Net annual cash flows Cost to rebuild (end of year 4) Salvage value Estimated useful life Option A Option B $135,000 $203,000 $31,000 $50,000 $40,000 $0 $10,000 8 years 8 years.