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 7% Initial cost Annual cash inflows Annual cash outflows Cost to rebuild (end of year 4) Salvage value Estimated useful life Option A Option $177,000 $268,000 $72,000 $81,700 $28,500 $25,600 $51,000 $0 $7,400 7 years 7 years $0 Click here to view the factor table,

Answer 1

NPV of A Year Cash inflow Outflow Net Cashflow PV factor @7% Present value of cashflow Present PV factor value of @ 10% cashflow for IRR 177000 72000 28500 72000 28500 72000 28500 72000 79500 72000 28500 72000 28500 72000 28500 -177000 43500 43500 43500 -7500 43500 43500 43500 1 -177000 0.934579439 40654.2 0.873438728 37994.6 0.816297877 35509 0.762895212 -5721.71 0.712986179 31014.9 0.666342224 28985.9 0.622749742 27089.6 18526.4 1 -177000 0.90909 39545.5 0.82645 35950.4 0.75131 32682.2 0.68301-5122.6 Cost to rebuild 0.62092 27010.1 0.56447 24554.6 0.51316 22322.4 -57.4677 NPV NPV of B PV factor Year Cash inflow Outflow Net Cashflow PV factor @ 7% Present value of cashflow @10% for IRR Present value of cashflow 268000 81700 25600 81700 25600 81700 25600 81700 25600 81700 25600 81700 25600 89100 25600 -268000 1 -268000 56100 0.934579439 52429.9 56100 0.873438728 48999.9 56100 0.816297877 45794.3 56100 0.762895212 42798.4 56100 0.712986179 39998.5 56100 0.666342224 63500 0.622749742 39544.6 1 -268000 0.90909 51000 0.82645 46363.6 0.75131 42148.8 0.68301 38317.1 0.62092 34833.7 0.56447 31667 0.51316 32585.5 Salvage value NPV 38947.5 8915.67

Profitability index Present value of cash Present value of cash inflows/Initial inflows/Initial investment investment Present value of cash inflov 18526.43316 38947.48352 Profitability index 0.10 0.15

Present value @ 7% 18526.43316 Present value @ 10% -57.46765398 Net Present Value of Plan A IRR Lower Rate +( NPV at Lower Rate * Difference between higher and lower rate / IRR 7+ ( 18526.43316*3)/(18526.43316-(-57.46765398)) IRR 9.99% Present value @ 7% 38947.48352 Present value @ 10% 8915.665747 Net Present Value of Plan B IRR Lower Rate +(NPV at Lower Rate * Difference between higher and lower rate/ IRR 7+(38947.48352*3)/(38947.48352-(8915.665747)) IRR 10.99%