Problem 24-3A (part level submission) Goltra Clinic is considering investing in
ID: 2499354 • Letter: P
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Problem 24-3A (part level submission) 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 7% Initial cost Annual cash inflows Annual cash outflows Cost to rebuild (end of year 4) Salvage value Estimated useful life Option A Option B $165,000 $268,000 $71,100 $82,900 $31,400 $25,100 $0 $8,400 years 7 years $49,800 (For calculation purposes, use 5 decimal places as displayed in the factor table provided.) (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 to 0 decimal places, e.g. 125. Round profitability index to 2 decimal places, e.g. 10.50. Round answers for IRR to 0 decimal places, e.g. 12.) Net Present Value Profitability Index Internal Rate of Return Option A Option BExplanation / Answer
Option A
Initial Cost = 165000
Annual Cash Inflow = 71100
Annual Cash Outflow = 31400
Annual Net cash Inflow = Annual Cash Inflow - Annual Cash Outflow
Annual Net cash Inflow = 71100-31400
Annual Net cash Inflow = 39700
Cost to rebuild at the end of year 4 = 49800
Salvage Value = 0
Estimated Useful life = 7
Net Present value = -Initial Cost + Annual Net cash Inflow *PVIFA(7%,7) - Cost to rebuild at the end of year 4 *PVIF(7%,4)
Net Present value = -165000 + 39700*5.38929 - 49800*0.76290
Net Present value = 10,962
Profitability Index = (1+Net Present value /Initial Cost)
Profitability Index = (1+ 10962/165000)
Profitability Index = 1.07 times
Internal Rate of Return :
At this Rate NPV is equal to zero
Net Present value = -Initial Cost + Annual Net cash Inflow *PVIFA(r,7) - Cost to rebuild at the end of year 4 *PVIF(r,4)
0 = -165000 + 39700*PVIFA(r,7) - 49800*PVIF(r,4)
By using Present Value table , using alternative discount rate to arrive at a IRR
IRR = 9%
Option B
Initial Cost = 268000
Annual Cash Inflow = 82900
Annual Cash Outflow = 25100
Annual Net cash Inflow = Annual Cash Inflow - Annual Cash Outflow
Annual Net cash Inflow = 82900-25100
Annual Net cash Inflow = 57800
Cost to rebuild at the end of year 4 = 0
Salvage Value = 8400
Estimated Useful life = 7
Net Present value = -Initial Cost + Annual Net cash Inflow *PVIFA(7%,7) + Salvage Value *PVIF(7%,7)
Net Present value = -268000 + 57800*5.38929 + 8400*0.62275
Net Present value = 48,732
Profitability Index = (1+Net Present value /Initial Cost)
Profitability Index = (1+ 48732/268000)
Profitability Index = 1.18 times
Internal Rate of Return :
At this Rate NPV is equal to zero
Net Present value = -Initial Cost + Annual Net cash Inflow *PVIFA(r,7) + Salvage Value*PVIF(r,7)
0 = -268000 + 57800*PVIFA(r,7)+ 8400*PVIF(r,7)
By using Present Value table , using alternative discount rate to arrive at a IRR
IRR = 12%
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