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