Goltra Clinic is considering investing in new heart-monitoring equipment. It has
ID: 2476927 • Letter: G
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. (Hint: To solve for internal rate of return, experiment with alternative discount rates to arrive at a net present value of zero.)
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Option A Option B Initial cost $170,000 $245,000 Annual cash inflows $72,100 $80,500 Annual cash outflows $29,000 $26,000 Cost to rebuild (end of year 4) $51,200 $0 Salvage value $0 $8,800 Estimated useful life 7 years 7 yearsExplanation / Answer
Year 0 1 2 3 4 5 6 7 NPV PI option A (170,000) Annual cash inflow 72,100 72,100 72,100 72,100 72,100 72,100 72,100 Annual cash outflow (29,000) (29,000) (29,000) (29,000) (29,000) (29,000) (29,000) Net cash flow 43,100 43,100 43,100 43,100 43,100 43,100 43,100 rebuild cost (51,200) Cash flow (170,000) 43,100 43,100 43,100 (8,100) 43,100 43,100 43,100 Discount factor 7% 1.000 0.935 0.873 0.816 0.763 0.713 0.667 0.623 (170,000) 40,299 37,626 35,170 (6,180) 30,730 28,748 26,851 23,243 1.14 (193243.4/170000) option B (245,000) Annual cash inflow 80,500 80,500 80,500 80,500 80,500 80,500 80,500 Annual cash outflow (26,000) (26,000) (26,000) (26,000) (26,000) (26,000) (26,000) Net cash flow 54,500 54,500 54,500 54,500 54,500 54,500 54,500 rebuild cost 8,800 Cash flow (245,000) 54,500 54,500 54,500 54,500 54,500 54,500 63,300 Discount factor 7% 1.000 0.935 0.873 0.816 0.763 0.713 0.667 0.623 (245,000) 50,958 47,579 44,472 41,584 38,859 36,352 39,436 54,237 1.22 (299237.4/245000) Year 0 1 2 3 4 5 6 7 NPV PI IRR option A (170,000) Annual cash inflow 72,100 72,100 72,100 72,100 72,100 72,100 72,100 Annual cash outflow (29,000) (29,000) (29,000) (29,000) (29,000) (29,000) (29,000) Net cash flow 43,100 43,100 43,100 43,100 43,100 43,100 43,100 rebuild cost (51,200) Cash flow (170,000) 43,100 43,100 43,100 (8,100) 43,100 43,100 43,100 Discount factor 11% 1.000 0.901 0.812 0.731 0.659 0.596 0.535 0.482 (170,000) 38,833 34,997 31,506 (5,338) 25,688 23,059 20,774 (481) 1.00 11% option B (245,000) Annual cash inflow 80,500 80,500 80,500 80,500 80,500 80,500 80,500 IRR Annual cash outflow (26,000) (26,000) (26,000) (26,000) (26,000) (26,000) (26,000) Net cash flow 54,500 54,500 54,500 54,500 54,500 54,500 54,500 rebuild cost 8,800 Cash flow (245,000) 54,500 54,500 54,500 54,500 54,500 54,500 63,300 Discount factor 13% 1.000 0.885 0.783 0.693 0.613 0.543 0.480 0.425 (245,000) 48,233 42,674 37,769 33,409 29,594 26,160 26,903 (261) 1.00 13%
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