Problem -
Brooks Clinic ls 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 6%.
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Option A
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Option B
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Initial cost
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$181,000
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$283,000
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Annual cash inflows
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$73,000
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$82,400
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Annual cash outflows
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$30,200
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$25,100
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Cost to rebuild (end of year 4)
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$48,000
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$0
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Salvage Value
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$0
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$8,300
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Estimated useful life
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7 years
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7 years
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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.)