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		$182,000		$283,000
Annual cash inflows		$72,800		$81,700
Annual cash outflows		$30,600		$26,500
Cost to rebuild (end of year 4)		$51,300		$0
Salvage value		$0		$8,600
Estimated useful life		7 years		7 years

Answer 1