The company is choosing between machine A and B (they are mutually exclusive and
ID: 2714176 • Letter: T
Question
The company is choosing between machine A and B (they are mutually exclusive and the company can only pick one). The initial cost of machine A is $400,000 and it will last for 7 years before it needs to be replaced. The cost of operating machine A each year is $50,000. The initial cost of Machine B is $280,000 and it will last for 5 years before it needs to be replaced. The cost of operating machine B is $70,000 in cash flow per year. If the required rate of return is 9%,
(a) Calculate the 7 year and 5 year annuity factors at 9% annual interest.
(b) Using the annuity factors, find the PV of Machine A and Machine B including all costs (initial + operating).
(c) Which machine is a better choice for the company after considering the different lives of the projects? (Note: be sure to use the equivalent annual annuity method)
Explanation / Answer
MACHINE A MACHINE B PURCHASE COST 4,00,000 2,80,000 LIFE OF MACHINE 7 YEARS 5 YEARS RUNING COST 50,000 70,000 CMULATIVE PV FACTOR 5.033 3.8897 PRESENT VALUE OF RUNNING COST 251650 272279 CASH OUTFLOW OF MACHINES 651650 552279 EQUIVALENT PRESENT VALUE OF ANNUAL CASH OUTFOW 129475.462 141984.986 THE COMPANY SHOULD BUY MACHINE A SINCE EQUIVALENT CASH OUTFLOW IS LESS THAN MACHINE B