Kimmel, Accounting, 6e Help I System Announcements CALCULATOR??pRINTER VERSIONI
ID: 2514549 • Letter: K
Question
Kimmel, Accounting, 6e Help I System Announcements CALCULATOR??pRINTER VERSIONI : 4EACK Brooks Clinic is considering investing in new heart-m oring equipment. It has two options. Option A would have an initial cost but would require a significant expenditure for rlding 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 6% Initial cost Annual cash inflows Annual cash outflows Cost to rebuild (end of year 4) Salvage value Estimated useful life Option A Option B $181,000 $283,000 $73,000 $82,400 $30,200 $25,100 $0 $0 $8,300 7 years7 years $48,000 Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option. (Hint: To internal rate of return, experiment with alternative discount rates to arrive at a net present value of zero.) (If the value is negative, use either a negative sign preceding the number eg-45 or parentheses eg (45). Round anwers for present value and IRR to 0 decimal places, e.g. 125 and round profitability index to 2 decimal places, eg·10.50 For calculation purposes, use 5 decimal places as displayed in the factor table provided.)Explanation / Answer
Solution a:
To compute IRR let calculate NPV of option A at 9% and 10% discount rate. Further lets calculate NPV of option B at 10% and 11% discount rate. IRR is the rate at which NPV of project will be zero.
As we have to round IRR at zero decimal place, therefore IRR for option A is 9%, becuase at 10% NPV is negative.
As we have to round IRR at zero decimal place, therefore IRR for option B is 10%, becuase at 11% NPV is negative.
Compuation of NPV and Profitability index Particulars Period PV Factor Option A Option B Amount Present value Amount Present value Cash Outflows: Initial Cost 0 1 $181,000 $181,000 $283,000 $283,000 Annual cash outflows 1-7 5.582381 $30,200 $168,588 $25,100 $140,118 Cost to rebuild 4 0.792094 $48,000 $38,020 $0 $0 Present value of cash outflows (A) $387,608 $423,118 Cash Inflows: Annual Cash Inflows 1-7 5.582381 $73,000 $407,514 $82,400 $459,988 Salvage Value 7 0.665057 $0 $0 $8,300 $5,520 Present Value of cash inflows (B) $407,514 $465,508 NPV (B-A) $19,905 $42,390 Profitability Index (PV of cash inflows / PV of cash outflows) 1.05 1.10Related Questions
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