Goltra Clinic is considering investing in new heart-monitoring equipment. It has

Question

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 7%. Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option. (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.)

Explanation / Answer

Project A

Net annual cash inflow = $72100 - $31800 = $40300

NPV

= PV of annual cash inflow - Pv of rebuilding cost - Initial Investment

= $40300 x PVIFA (7%,7) - $48100 x PVIF (7%, 4) - $174000

= $40300 x 5.389 - $48100 x 0.763 - $174000

= $6476.40

Profitability index

= 1 + NPV/PV of cash Outlay

= 1 + $6476.40 / ($48100 x PVIF (7%, 4) + $174000)

= 1 + $6476.40//210700.30 = 1.031

IRR: IRR is the discount rate at which NPV will be zero.

NPV at 17%

= $40300 x PVIFA (17%,7) - $48100 x PVIF (17%, 4) - $174000

= $40300 x 3.923 - $48100 x 0.534 - $174000

= - $41588.50

R = 7% + 10% * ((0-6476.4)/(-41588.5-6476.4)) = 8.35%

Project B

Net annual cash inflow = $80000 - $26700 = $53300

NPV

= PV of annual cash inflow PV of salvage value - Initial Investment

= $53300 x PVIFA (7%,7) + $7800 x PVIF (7%, 7) - $255000

= $53300 x 5.389 + $7800 x 0.623 - $255000

= $37093

Profitability index

= 1 + NPV/PV of cash Outlay

= 1 + $6476.40 / $174000 = 1.037

IRR: IRR is the discount rate at which NPV will be zero.

NPV at 17%

= $53300 x PVIFA (17%,7) + $7800 x PVIF (17%, 7) - $255000

= $53300 x 3.923 + $7800 x 0.333 - $255000

= - $43307

R = 7% + 10% * ((0-37093)/(-43307-37093)) = 11.61%

Rate NPV 7% 6476.4 R 0 17% -41588.5

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.