Split - Finance Homework

kea1220

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Please help!!!
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 11%.
Option A Option B
Initial cost $160,000 $227,000
Annual cash inflows $75,000 $80,000
Annual cash outflows $35,000 $30,000
Cost to rebuild (end of year 4) $60,000 $ 0
Salvage value $ 0 $12,000
Estimated useful life 8 years 8 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.) (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round computations and final answer for present value to 0 decimal places, e.g. 125. Round profitability index to 2 decimal places, e.g. 10.50. Round answer for IRR to 0 decimal place, e.g. 12. Round computations for Discount Factor to 5 decimal places.)
Net Present Value Profitability Index Internal Rate of Return
Option A $ 6321 12 %
Option B $ 15 %
 
kea1220 said:
Please help!!!
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 11%.
Option A Option B
Initial cost $160,000 $227,000
Annual cash inflows $75,000 $80,000
Annual cash outflows $35,000 $30,000
Cost to rebuild (end of year 4) $60,000 $ 0
Salvage value $ 0 $12,000
Estimated useful life 8 years 8 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.) (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round computations and final answer for present value to 0 decimal places, e.g. 125. Round profitability index to 2 decimal places, e.g. 10.50. Round answer for IRR to 0 decimal place, e.g. 12. Round computations for Discount Factor to 5 decimal places.)
Net Present Value Profitability Index Internal Rate of Return
Option A $ 6321 12 %
Option B $ 15 %

Please share your work with us, indicating exactly where you are stuck - so that we may know where to begin to help you.
 
I'm not sure how to calculate the net present value of option B, the rest was given to us.
 
kea1220 said:
I'm not sure how to calculate the net present value of option B, the rest was given to us.
You're "not sure"? :shock: Anyway, you're given this on B:

The company's cost of capital is 11%.
Annual cash inflows: $80,000
Annual cash outflows: $30,000
Salvage value: $12,000
Estimated useful life: 8 years
SO:
Net flow = 80000 - 30000 = 50000

Step 1: find present value of 8 annual flows of $50,000, using 11%
Step 2: find present value of $12,000: discounted for 8 years at 11%
Step 3: add 'em up!
 
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