Mar Vista Molding Company is considering investing in new therrnokillian equipment. It has two options: Option A would have an initial lower cost but would require a significant expenditure for rebuilding after 3 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:
|
Option A |
Option B |
|
|
Initial cost |
$53,000 |
$58,000 |
|
Annual cash inflows |
$30,000 |
$30,000 |
|
Annual cash outflows |
$15,000 |
$18,000 |
|
Cost to rebuild (end of year 3) |
$12,000 |
$ -0- |
|
Salvage value |
S -0- |
510,000 |
|
Estimated useful life |
6 years |
6 years |
The company”s cost of capital is 8%.
Instructions
(a) Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option.
(b) Which option should be accepted?
