Carolina Clinic is considering investing in new heart monitoring equipment. It has two options: Option A would

Question:

Carolina 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 companys cost of capital is 11%.

Option A Option B

Initial cost $169,600 $240,620

Annual cash inflows $79,500 $84,800

Annual cash outflows $37,100 $31,800

Cost to rebuild (end of year 4) $63,600 $ 0

salvage value $ 0 $12,720

Estimated useful life 8 years 8 years

(a) Compute the

(1) Net present value,

(2) Profitability index, and

(3) Internal rate of return for each option.

Option A $ 6,321 12 %

Option B $ 15 %

B) Which option should be accepted?

Net Present Value
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... Internal Rate of Return
Internal Rate of Return of IRR is a capital budgeting tool that is used to assess the viability of an investment opportunity. IRR is the true rate of return that a project is capable of generating. It is a metric that tells you about the investment... Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...