Question

1. 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 company's cost of capital is 8%.

	Option A	Option B
Initial cost	$160,000	$227,000
Annual cash inflows	$71,000	$80,000
Annual cash outflows	$30,000	$31,000
Cost to rebuild (end of year 4)	$50,000	$0
Salvage value	$0	$8,000
Estimated useful life	7 years	7 years

Instructions

a.  1.

Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option.

b.  

Which option should be accepted? Explain your answer!

Answer 1