Problem 26-3A Brooks Clinic is considering investing in new heart-monitoring equ

Question

Problem 26-3A Brooks 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 6% Option A Option B $181,000 $283,000 $73,000 $82,400 $30,200 $25,100 Initial cost Annual cash inflows Annual cash outflows Cost to rebuild (end of year 4) Salvage value Estimated useful life $48,000 $0$8,300 7 years 7 years 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.) (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 and IRR to 0 decimal places, e.g. 125 and round profitability index to 2 decimal places, e.g. 12.50. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Net Present Value Profitability Index Internal Rate of Return Option A Option B

Explanation / Answer

Option A Cash flow PV factor 6% PV of Cash Flow 0 -181000 1 -181000 1 42800 0.94340 40377 2 42800 0.89000 38092 3 42800 0.83962 35936 4 -5200 0.79209 -4119 5 42800 0.74726 31983 6 42800 0.70496 30172 7 42800 0.66506 28464 Net Present Value 19905 Profitability Index= (NPV/Intial Investment)+1=(19905/181000)+1 1.1 IRR Using Excel IRR Funtion 9% Option B Cash flow PV factor 6% PV of Cash Flow 0 -283000 1 -283000 1 57300 0.94340 54056.60377 2 57300 0.89000 50996.79601 3 57300 0.83962 48110.18492 4 57300 0.79209 45386.9669 5 57300 0.74726 42817.89331 6 57300 0.70496 40394.23897 7 65600 0.66506 43627.74665 Net Present Value 42390 Profitability Index= (NPV/Intial Investment)+1=(144390/283000)+1 1.15 IRR Using Excel IRR Funtion 10%

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