Goltra 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%.
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Option B |
|
|
Initial cost |
$160,000 |
$227,000 |
|
Annual cash inflows |
$70,000 |
$80,000 |
|
Annual cash outflows |
$30,000 |
$26,000 |
|
Cost to rebuild (end of year 4) |
$50,000 |
$0 |
|
Salvage value |
$0 |
$8,000 |
|
Estimated useful life |
7 years |
7 years |
Instructions
(a)Compute the (1) net present value and (2) 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.)
(b)Which option should be accepted?
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