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 8%. Initial cost Annual cash inflows Annual cash outflows Cost to rebuild (end of year 4) Salvage value Estimated useful life Option A $160,000 $71,000 $30,000 $50,000 $0 7 years Option B $227,000 $80,000 $31,000 $0 $8,000 7 years Click here to view PV table. (a) Your answer is partially correct. Try again. 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 1.10 % Option B T 1.14

Answer 1

solution a 1 Net present value : option to present value present value factor of 8% of 7th Year PuIF (8%,7) = 0.5834 Factor of 8% for a Years PNAF ( 8% 7) = 5.2064

present value of cash outflows = (Annual cash Inflower - Annual cash outflows XPVAF(847) =(alooo - goooo)* 5-20+ - 50000 (0.) - 213467.4 - 36750 : = 176812.4 Present value of Initial Investment - 160ooo X1 = 16000 6 Net present value of option = 176712.4- 160000 = 16719.4 option Bi present value factor of 8% of a th Year PvIF ( 80%, 7) = 0.5834 present value factor of 8% of 7 years PNAF (8% 7) = 5.2064 present value of salvage value = 6000 x 0.5834 = 4667.2 present value of cash outflows = (Annual cash In flows - Annual cash outflows ) X PVAF(84,7) ( 80000 - 3logo) x 5. 2064 = 255113.6 Present value of Initial Investment = 227ooox 1 = 277000 Net present value of option 1 = 255113. 6 + 4667,2-227000 - 32780.8

2) profitability Index: formulae = Discounted cash flows / cash outlay option A = 16712.4 + 160000/ 160000 = 1.10 ophon B = 38780+ 227000 227000 = 1-14 3) Internal rate of return :- option A- payback period = cash outflow / Annual cash Inflowę - 160000 / 170000 - 30000) = 160000 | 41000 = 3.90 years The present value annuity table for a years, we need to select the two fegures one of which must be more than 3.9 and the other lesser than 3.9, so we get 17% (3.922) and 18:47 | 3.612) So, IRR = 177% +(30922-3-4)/(3.922 - 3.812) X (1814–177) = 17% + (0.022/0.11) X1 17%. + 0.21 = 17.2% option B: payback period & Cash outflow/ Annual Cash Inflower = 227000 / C80000 - 31000) = 227000 /49000 4.63 years

the present value annulty Table, for 7 years we need to select the two figures one of which must be more than 4.63 and the other resser than 4.6. so we will get 11% (4.712) and 12% (4.564). 30, IRR = 11% + (40712-4-63)/(4.712-40564) x(12% -1107) -11% + (0.082/0.148) x 1 = 11%. + 0. 5541% I 11.5541%