Goltra clinic is consideriing investing in new heart-monitorihng equipment. It h

Question

Goltra clinic is consideriing investing in new heart-monitorihng equipment. It has two options: Option A would have an intial lower cost but would rerquire a significant expenditure for rebounding after 4 years, Option B would require no rebuilding expenditure, but its maintenance costs would be higher. Since the option B machines is of intial higher quality, it is expected to have a salvage valve at the end of its useful life. The follwing estimates were made of the cash flows. The company's cost of capital is 8%. Compute the (1) net present valve, (2) profitability index, and (3) internal rate of return for each option.

Explanation / Answer

Option A:

-21190.89492

Profitability Index = PV of Future Cash Flows/ Initial Cost = (37685.19+34893.69-6033.12+29915.72+27699.74+25647.90) / 171000 = .88

IRR = PV of cash outflows = PV of Cash Inflows

IRR = 3.90%, On using alternative rates, the PV of cash outflows equals PV of cash inflows at 3.90%

Option B

Profitability Index = PV of Future Cash Flows/ Initial Cost = (50277.78+46553.50+43105.09+39912.12+26995.67+39448.62) / 244000 = 1.05

IRR = PV of cash outflows = PV of Cash Inflows

IRR = 9.60%, On using alternative rates, the PV of cash outflows equals PV of cash inflows at 9.60%(approx)

Year Cash Out flow Cash Inflow Net Cash Flow PV Factor Present Value 1 171000 -171000 1 -171000 2 29600 70300 40700 0.9259 37685.18519 3 29600 70300 40700 0.8573 34893.68999 4 77900 70300 -7600 0.7938 -6033.125032 5 29600 70300 40700 0.7350 29915.71501 6 29600 70300 40700 0.6806 27699.73612 7 29600 70300 40700 0.6302 25647.90381 Net Present Value

-21190.89492

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