Problem 24-3A (part level submission) (a) B. Which option should be accepted? Pr

Question

Problem 24-3A (part level submission)

(a)

B. Which option should be accepted?

Problem 24-3A (part level submission)

Goltra 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 9%.
Option A Option B Initial cost $164,000 $238,000 Annual cash inflows $71,900 $80,800 Annual cash outflows $31,300 $26,000 Cost to rebuild (end of year 4) $49,200 $0 Salvage value $0 $8,200 Estimated useful life 7 years 7 years

Click here to view the factor table.

(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

(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.) (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 to 0 decimal places, e.g. 125. Round profitability index to 2 decimal places, e.g. 10.50. Round answers for IRR to 0 decimal places, e.g. 12.)
Net Present Value Profitability Index Internal Rate of Return Option A $ % Option B $ %

B. Which option should be accepted?

Explanation / Answer

Calculation Of NPV Project a Poject B year Cash Flow Discount factor 9% Discounted Cash Flow Discount factor 10% Discounted Cash Flow year Cash Flow Discount factor 9% Discounted Cash Flow Discount factor 14% Discounted Cash Flow 0 -164000 1 -164000 1 -164000 0 -238000 1 -238000 1 -238000 1 $40,600 0.9174 37247.71 0.9091 36909.09 1 $54,800 0.9174 50275.23 0.8772 48070.18 2 $40,600 0.841679993 34172.21 0.826446 33553.72 2 $54,800 0.84168 46124.06 0.769468 42166.82 3 $40,600 0.7722 31350.65 0.751315 30503.38 3 $54,800 0.7722 42315.65 0.674972 36988.44 4 $40,600 0.7084 28762.06 0.683013 27730.35 4 $54,800 0.7084 38821.7 0.59208 32446.00 4 -49200 0.7084 -34854.5 0.6830 -33604.3 5 $54,800 0.6499 35616.24 0.519369 28461.40 5 $40,600 0.6499 26387.21 0.6209 25209.41 6 $54,800 0.5963 32675.45 0.455587 24966.14 6 $40,600 0.5963 24208.45 0.5645 22917.64 7 $54,800 0.5470 29977.48 0.399637 21900.13 7 $40,600 0.5470 22209.59 0.5132 20834.22 7 $8,200 0.5470 4485.681 0.3996 3277.03 NPV 5483.365 NPV 53.54199 NPV 42291.5 NPV 276.13 Profitability Index=1+NPV/Initial Investment 1+5483/164000 1.03 Profitability Index=1+NPV/Initial Investment 1+(42291/238000) 1.18 IRR where NPV=0 from trial and error lets take 10% as at 9% it is positive IRR where NPV=0 from trial and error lets take 14% as at 9% it is positive and $42291 so we have to increase the % more IRR is approximate 10% may be 10.1% you can take IRR is approximate a bit higher than 14% Net Present Value Profitability Index Internal Rate of Return Option A 5483 1.03 10 % Option B 42291 1.18 14 %

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