Mar Vista Molding Company is considering investing in new therrnokillian equipment. It has two options: Option A would have an initial lower cost but would require a significant expenditure for rebuilding after 3 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:
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Option A
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Option B
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Initial cost
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$53,000
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$58,000
|
|
Annual cash inflows
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$30,000
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$30,000
|
|
Annual cash outflows
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$15,000
|
$18,000
|
|
Cost to rebuild (end of year 3)
|
$12,000
|
$ -0-
|
|
Salvage value
|
S -0-
|
510,000
|
|
Estimated useful life
|
6 years
|
6 years
|
The company"s cost of capital is 8%.
Instructions
(a) Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option.
(b) Which option should be accepted?