Compute net present value, profitability index, and internal rate of return. P25-3 (LO 2, 3, 4),...

Transcribed Image Text:

Compute net present value, profitability index, and internal rate of return. P25-3 (LO 2, 3, 4), AN Service 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%. Initial cost Annual cash inflows Annual cash outflows Option A Option B $160,000 $227,000 $71,000 $80,000 $30,000 $31,000 Cost to rebuild (end of year 4) Salvage value $50,000 $0 $0 $8,000 Estimated useful life 7 years 7 years Instructions 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.) a. (1) NPV A $16,709 (3) IRR B 12% b. Which option should be accepted? Compute net present value, profitability index, and internal rate of return. P25-3 (LO 2, 3, 4), AN Service 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%. Initial cost Annual cash inflows Annual cash outflows Option A Option B $160,000 $227,000 $71,000 $80,000 $30,000 $31,000 Cost to rebuild (end of year 4) Salvage value $50,000 $0 $0 $8,000 Estimated useful life 7 years 7 years Instructions 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.) a. (1) NPV A $16,709 (3) IRR B 12% b. Which option should be accepted?