Question

Bonita Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn’t equipped to do. Estimates regarding each machine are provided below.

		Machine A		Machine B
Original cost		$77,500		$186,000
Estimated life		8 years		8 years
Salvage value		0		0
Estimated annual cash inflows		$19,500		$39,600
Estimated annual cash outflows		$5,040		$9,800

Click here to view PV table.

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer for present value to 0 decimal places, e.g. 125 and profitability index to 2 decimal places, e.g. 10.50. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

		Machine A		Machine B
Net present value
Profitability index

Which machine should be purchased?

a. Machine B

b. Machine A

should be purchased.

Answer 1

Computation of Present Values:

1. Machine A:

   Year	Cash flows	PV factor at 9%	Discounted Cashflows
   0	-77,500	1.0000	-77,500.00
   1-8	14,460#	5.5348	+80,033.20
   		NPV	2,533.20

   #Cash outflow - Cash inflow = 19500-5040

2. Machine B:

   Year	Cash flows	Discount factor @ 9%	Discounted cashflows
   0	-186,000	1.0000	-186,000.00
   1-8	29,800	5.5348	164,937.04
   		NPV	-21,062.96

Profitability Index: PV of cash inflows/Intial Outlay

• Machine A:80,033.20/77,500 = 1.03
• Machine B: 164,937.04/186,000 = 0.89

Since NPV of Machine A as well as the profitabilty index is higher than Machine B, it is recommended to purchase machine A.