Question
Brooks 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
Brooks 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 companys cost of capital is 6%.
Option A | Option B | ||||
Initial cost | $181,000 | $283,000 | |||
Annual cash inflows | $73,000 | $82,400 | |||
Annual cash outflows | $30,200 | $25,100 | |||
Cost to rebuild (end of year 4) | $48,000 | $0 | |||
Salvage value | $0 | $8,300 | |||
Estimated useful life | 7 years | 7 years |
Compute the (1) net present value, (2) profitability index, and (3) 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.) (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answers for present value and IRR to 0 decimal places, e.g. 125 and round profitability index to 2 decimal places, e.g. 12.50. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
Net Present Value | Profitability Index | Internal Rate of Return | |||||
Option A | $ | % | |||||
Option B | $ | % |
Which option should be accepted?
Choose your answer here Option A or Option B |
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