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Question - 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 5%.
Option A
Option B
Initial cost
$196,000
$291,000
Annual cash inflows
$72,500
$82,500
Annual cash outflows
$28,000
$25,600
Cost to rebuild (end of year 4)
$49,100
$0
Salvage value
$8,500
Estimated useful life
7 years
Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option. Which option should be accepted?
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