Question

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 8%.

		Option A		Option B
Initial cost		$160,000		$227,000
Annual cash inflows		$71,000		$80,000
Annual cash outflows		$30,000		$31,000
Cost to rebuild (end of year 4)		$50,000		$0
Salvage value		$0		$8,000
Estimated useful life		7 years		7 years

	Net Present Value	Profitability Index	Internal Rate of Return
Option A	$16709	1.10	?????????
Option B	$32780	1.14	?????????

Answer 1

	Cash Flows
Years	Option A	Option B
0	$(160,000.00)	$(227,000.00)
1	$    41,000.00	$    49,000.00
2	$    41,000.00	$    49,000.00
3	$    41,000.00	$    49,000.00
4	$     (9,000.00)	$    49,000.00
5	$    41,000.00	$    49,000.00
6	$    41,000.00	$    49,000.00
7	$    41,000.00	$    57,000.00
IRR	11.05%	12.03%

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