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Carolina Clinic 160000

Price: $2.50

Carolina 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

(a) 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.)

(b) Which option should be accepted?

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