Carolina Clinic is considering investing in new heart monitoring equipment. Caro

Question

Carolina Clinic is considering investing in new heart monitoring equipment. Carolina 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

Explanation / Answer

The company’s
cost of capital is 11%.

Option A ---------------------------------------------------------Option B
Initial cost $160,000 -----------------------------------------$227,000
Annual cash inflows $75,000-------------------------------- $80,000
Annual cash outflows $35,000-------------------------------- $30,000
Cost to rebuild (end of year 4) $60,000----------------------------- $0
Salvage value $0 -------------------------------------------------------$12,000
Estimated useful life 8 years-------------------------------------- 8 years

(1) net present value,

(40000 x5.1462---60000x.65873 ) 166321

(50000 x5.1462+ 12000x.43393 ) 280,518

LESS INITIAL INVESTMNET 160000 227,000

net present value, 6,321 53,518

(2) profitability index,

1.04, 1.24



(3)internal rate of return for each option

4, 4.54

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