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 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 5%.

		Option A		Option B
Initial cost		$193,000		$288,000
Annual cash inflows		$72,700		$81,800
Annual cash outflows		$28,400		$25,400
Cost to rebuild (end of year 4)		$51,500		$0
Salvage value		$0		$7,000
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.) What is the optimal option? (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		$				%

Answer 1

Note

If you have any queries kindly post a comment, i will solve it earliest.

If you satisfied with my answer, kindly give a thumbs up, it will help to encourage me.