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%.
Option A Option B Initial cost $180,000 $253,000 Annual cash inflows $71,500 $82,800 Annual cash outflows $28,500 $26,300 Cost to rebuild (end of year 4) $51,100 $0 Salvage value $0 $7,400 Estimated useful life 7 years 7 years

Explanation / Answer

Based on above data , it is better to Select Option"B" because of higher NPV, Profitability Index and IRR.

Workings:

Net Present Vaue Pofitability Index Internal rate of return (%) Option A            12,755 1.06 9 % Option B            56,103 1.22 14 %

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