(a) Goltra Clinic is considering investing in new heart-monitoring equipment. It
ID: 2468232 • Letter: #
Question
(a)
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 8%.Option A Option B Initial cost $160,000 $227,000 Annual cash inflows $70,000 $80,000 Annual cash outflows $30,000 $26,000 Cost to rebuild (end of year 4) $50,000 $0 Salvage value $0 $8,000 Estimated useful life 7 years 7 years
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(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
Explanation / Answer
Project A Project B Year PV Factor @8% Investment & Rebuild Cost Net Annual Cash Inflow Salvage Net Cash Flow PV of Cash flows Investment & Rebuild Cost Net Annual Cash Inflow Salvage Net Cash Flow PV of Cash flows Year 0 1.00000 (160,000) (160,000) (160,000) (227,000) (227,000) (227,000) Year 1 0.92593 40,000 40,000 37,037 54,000 54,000 50,000 Year 2 0.85734 40,000 40,000 34,294 54,000 54,000 46,296 Year 3 0.79383 40,000 40,000 31,753 54,000 54,000 42,867 Year 4 0.73503 (50,000) 40,000 (10,000) (7,350) 54,000 54,000 39,692 Year 5 0.68058 40,000 40,000 27,223 54,000 54,000 36,751 Year 6 0.63017 40,000 40,000 25,207 54,000 54,000 34,029 Year 7 0.58349 40,000 - 40,000 23,340 54,000 8,000 62,000 36,176 PV of Cash Inflows 208,255 285,812 PV of Investments 196,752 227,000 NPV = 11,503 58,812 PI =PV of cash inflows/PV of investments= 1.05847 1.2591 IRR = 10.11% 15.10% Project A Year PV Factor @10.11% Investment & Rebuild Cost Net Annual Cash Inflow Salvage Net Cash Flow PV of Cash flows Year 0 1.00000 (160,000) (160,000) (160,000) Year 1 0.90818 40,000 40,000 36,327 Year 2 0.82480 40,000 40,000 32,992 Year 3 0.74907 40,000 40,000 29,963 Year 4 0.68029 (50,000) 40,000 (10,000) (6,803) Year 5 0.61783 40,000 40,000 24,713 Year 6 0.56110 40,000 40,000 22,444 Year 7 0.50958 40,000 - 40,000 20,383 NPV 19 So IRR is 10.11% at which rate NPV = close to 0. Project B Year PV Factor @15.1% Investment & Rebuild Cost Net Annual Cash Inflow Salvage Net Cash Flow PV of Cash flows Year 0 1.00000 (227,000) (227,000) (227,000) Year 1 0.86881 54,000 54,000 46,916 Year 2 0.75483 54,000 54,000 40,761 Year 3 0.65580 54,000 54,000 35,413 Year 4 0.56977 54,000 54,000 30,768 Year 5 0.49502 54,000 54,000 26,731 Year 6 0.43008 54,000 54,000 23,224 Year 7 0.37366 54,000 8,000 62,000 23,167 NPV (20) So IRR is 15.1% at which rate NPV = close to 0.
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