Aqua Tech Testing is considering investing in a new testing device. It has two options: Option A would have an initial lower cost but would require a significant expenditure for rebuilding after 5 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 provided. The company’s cost of capital is 9%.

Instructions

(a) Compute the

(1) Net present value, and

(2) Internal rate of return for each option.

(b) Which option should be accepted?

Option A Option B Initial cost Net annual cash flows Cost to rebuild (end of year 5) Salvage value Estimated useful life $90,000 $170,000 $20,000 $26,500 $0 $32,000 $0 $27,500 8 years 8 years