Problem 12-3A Brooks Clinic is considering investing in new heart-monitoring equ

Question

Problem 12-3A Brooks Clinic is considering investing in new heart-monitoring equipment. It has two options. Option A would have a nitial 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%. Initial cost Annual cash inflows Annual cash outflows Cost to rebuild (end of year 4) Salvage value Estimated useful life Option A Option B $193,000 $288,000 $72,700 $81,800 $28,400 $25,400 $0 $0 $7,000 7 years 7 years $51,500 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.) (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 LINK TO TEXT LINK TO TEXT LINK TO TEXT VIDEO: SIMILAR PROBLEM Which option should be accepted? should be accepted LINK TO TEXT LINK TO TEXTLINK TO TEXT VIDEO: SIMILAR PROBLEM

Explanation / Answer

Calculation ;-

1)

2) Profitability Index ;-

= (NPV + Initial Investment )/ Initial Investment

Option A = (20967+193000) / 193000 = 1.11

Option B = (43326+288000) / 288000 = 1.15

3) Internal Rate of Return :-(Calculation on online Calculator)

Option A = 7.97% or 8%

Option B = 8.97% or 9%

Option A Option B Factor@5% Option A(NPV) Option B(NPV) Initial Cost 193000 288000 1 (193000) (288000) Estimated Useful life 7 7 Annual Cash Inflows 72700 81800 5.78637 420669 473325 Annual Cash Outflow 28400 25400 5.78637 (164333) (146974) Cost to Rebuild (End of Year 4) 51500 0.8227 (42369) Salvage Value 7000 0.71068 4975 NPV 20967 43326

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