Goltra 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 7%.
|
|
Option A |
|
Option B |
|
| Initial cost |
|
$178,000 |
|
$252,000 |
|
| Annual cash inflows |
|
$71,300 |
|
$82,100 |
|
| Annual cash outflows |
|
$29,000 |
|
$26,000 |
|
| Cost to rebuild (end of year 4) |
|
$49,600 |
|
$0 |
|
| Salvage value |
|
$0 |
|
$8,600 |
|
| 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.)
|
|
Net Present Value |
|
Profitability Index |
|
Internal Rate of Return |
|
| Option A |
|
$ |
|
|
|
% |
|
| Option B |
|
$ |
|
|
|
% |