Question

Tim Smunt has been asked to evaluate two machines. After some​ investigation, he determines that they have the costs shown in the following​ table:                                                                                                  

	Machine A		Machine B
Original Cost	$15,000		$24,000
Labor per year	$2,200		$4,800
Maintenance per year	$4,600		$1,200
Salvage value	$1,600		$7,500

He is told to assume​ that:

1. The life of each machine is 3 years.

2. The company thinks it knows how to make 8​% on investments no more risky than this one.

3. Labor and maintenance are paid at the end of the year.

Questions:

The NPV for Machine A =​ $ ?

The NPV for Machine B =​ $ ?

Using the net present value as the basis of comparing the​ machines, Tim should recommend which machine?

Answer 1

Answer:

NPV = Sum of PV's of all cashflows.

PV = Cashflow*(1/(1+i)^n)

For Machine A -

Cashflow at year 0 = -15000

Cashflow at year 1 = -2200-4600 = -6800

Cashflow at year 2 = -2200-4600 = -6800

Cashflow at year 3 = -2200-4600+1600 = -5200

NPV = -15000*(1/(1+0.08)^0) -6800*(1/(1+0.08)^1)-6800*(1/(1+0.08)^2)-5200*(1/(1+0.08)^3)

NPV = -31254.13

NPV = -31254

For Machine B -

Cashflow at year 0 = -24000

Cashflow at year 1 = -4800-1200 = -6000

Cashflow at year 2 = -4800-1200 = -6000

Cashflow at year 3 = -4800-1200+7500 = 1500

NPV = -24000*(1/(1+0.08)^0)-6000*(1/(1+0.09)^1)-6000*(1/(1+0.08)^2)+1500*(1/(1+0.08)^3)

NPV = -33,458

NPV = -33,458

Since NPV for Machine A is higher than Machine B, hence, Machine A should be used.