Question

Your company is deciding whether to invest in a new machine. The new machine will increase cash flow by $270,000 per year. You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will be obsolete 10 years from today. The machine is currently priced at $1,600,000. The cost of the machine will decline by $155,000 per year until it reaches $980,000, where it will remain.

  

If your required return is 11 percent, which year should you purchase the machine?

     

What is the NPV if you purchase the machine in the optimal year?

     

Answer 1

Which year should you purchase the machine?

Answer: Fifth year (5th year) is optimal to purchase as NPV is higher in that year.

What is the NPV if you purchase the machine in the optimal year?

Answer: NPV in the optimal year is $496709

Solution:

Statement showing NPV and Optimal year of Purchase:

Year of purchase	Cost of the machine	Present value factor @11%	Present value of the machine	Present value annuity factor	Annual cash inflows	Present value of cash inflows	NPV
1	1600000	1	1600000	5.8892	270000	1590084	-9916
2	1445000	0.9009	1301801	5.537	270000	1494990	193190
3	1290000	0.8116	1046964	5.1461	270000	1389447	342483
4	1135000	0.7312	829912	4.7122	270000	1272294	442382
5	980000	0.6587	645526	4.2305	270000	1142235	496709