Problem 24-3A (Part Level Submission) Brooks Clinic is considering investing in

Question

Problem 24-3A (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 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 $170,000 $263,000 $72,700 82,000 $30,500 26,900 $0 $0 $7,900 7 years 7 years $51,800 lick here iew abl (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

Option A Option B Initial Cost                    170,000                    263,000 Annual Cash Inflow                      72,700                      82,000 Annual Cash OutFlow                      30,500                      26,900 Net Cash Inflow                      42,200                      55,100 Cost to Rebuild at end of year 4                      51,800                                -   Salvage Value                                -                           7,900 Estimated useful life (Years)                                 7                                 7 P/V of inflows P/v of annual inflows =42,200 x 5.3893 =55,100 x 5.3893 Annual net inflow x cdf(7%,7years) P/v of annual inflows                    227,428                    296,950 P/v of Salvage                                -   =7900 / 1.07^7                         4,920 Total P/V of inflows                    227,428                    301,870 P/V of outflows Initial Investment                    170,000                    263,000 P/v of cost to rebuild                      39,518                                -   (51800/1.07^4) Total P/V of outflows                    209,518                    263,000 Net Present Value                      17,910                      38,870 Profitability Index                           1.09                           1.15 (P/v of future inflow / Investment cost) Using trial and error for keeping NPV as zero, I have calculated IRR as: 10.0% 11.0%

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