Question

Problem 25-03A 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 6%. Option A $181,000 $73,000 $30,200 $48,000 Option B $283,000 $82,400 $25,100 Initial cost Annual cash inflows Annual cash outflows Cost to rebuild (end of year 4) Salvage value Estimated useful life $0 $0 $8,300 7 years 7 years Click here to view the factor table. 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

Answer 1

		Option A	Option B
	Initial cost	-$181,000	-$283,000
	Annual cash inflows	$73,000	$82,400
	Less: Annual cash outflows	$30,200	$25,100
	Net cash inflows per year	$42,800	$57,300
			Option A	Present value of $1 @6%	Present value	Option B	Present value
		Year	Net cash inflow
		0	-$181,000			-$283,000
		1	$42,800	0.9434	$40,378	$57,300	$54,057
		2	$42,800	0.89	$38,092	$57,300	$50,997
		3	$42,800	0.83962	$35,936	$57,300	$48,110
		4	-$5,200	0.79209	-$4,119	$57,300	$45,387		(42800-48000)
		5	$42,800	0.74726	$31,983	$57,300	$42,818
		6	$42,800	0.70496	$30,172	$57,300	$40,394
		7	$42,800	0.66506	$28,465	$65,600	$43,628		(57000+8300)
					$200,907		$325,391
		Less: initial investment			-$181,000		-$283,000
					$19,907		$42,391
		Profitability index(PV/initial invet)			1.11		1.15
		IRR	9.07%			10.02%
			(IRR(values)			(IRR(values)
		NPV	Profitability index	IRR
	Option A	$19,907	1.11	9.07%
	Option B	$42,391	1.15	10.02%
	Option B should be accepted.

*Please note that final answers might differ due to rounding off. if you face any difficulty please let me know in the comment section. I'll give different rounded off solution then.