Carolina 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 11%. Option A Option B Initial cost $160,000 $227,000 Annual cash inflows $75,000 $80,000 Annual cash outflows $35,000 $30,000 Cost to rebuild (end of year 4) $60,000 $0 Salvage value $0 $12,000 Estimated useful life 8 years 8 years
Instructions
(a) 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.)
(b) Which option should be accepted? Compute net present value considering intangible benefits.