Problem 26-3A (Part Level Submission) (a) Problem 26-3A (Part Level Submission)

Question

Problem 26-3A (Part Level Submission)

(a)

Problem 26-3A (Part Level Submission)

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 5%.
Option A Option B Initial cost $196,000 $291,000 Annual cash inflows $72,500 $82,500 Annual cash outflows $28,000 $25,600 Cost to rebuild (end of year 4) $49,100 $0 Salvage value $0 $8,500 Estimated useful life 7 years 7 years
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(a)

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. 10.50. 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

(1) net present value

(2) profitability index,

(3) internal rate of return for each option.

Net Present Value

Profitability Index

Internal Rate of Return

Option A

$26,599

0.14

9.59 %

Option B

$44,285

0.15

8.96%

Option A Option B Annual cash inflow $72,500 $82,500 Annual cash outflow $28,000 $25,600 Net cash inflow $44,500 $56,900 Computation Of Present Value Option A Option B Year PV Factor Cash Flow Present Value Cash Flow Present Value 1 1 -$1,96,000 -$1,96,000 -$2,91,000 -$2,91,000 1 0.95238 $44,500 $42,381 $56,900 $54,190 2 0.90703 $44,500 $40,363 $56,900 $51,610 3 0.86384 $44,500 $38,441 $56,900 $49,152 4 0.82270 $44,500 $36,610 $56,900 $46,812 5 0.78353 $44,500 $34,867 $56,900 $44,583 6 0.74622 $44,500 $33,207 $56,900 $42,460 7 0.71068 $44,500 $31,625 $56,900 $40,438 7 0.71068 -$49,100 -$34,894 $8,500 $6,041         Net Present Value $26,599 $44,285

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