Question

BAK 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 $75,700 $189,000

Estimated life 8 years 8 years

Salvage value 0 0

Estimated annual cash inflows $19,800 $39,800

Estimated annual cash outflows $4,990 $10,100

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.)

Machines A Machine B

Net present value

Profitability index

Answer 1

Solution:

Machine should be selected based on Net present value of each machine.

Net present value = Discounted Inflow - Discounted Outflow

Assume rate of return of company is 9%

Net present value of Machine A:

Initial outflow = $75,700

Net annual cash inflow = $19,800 - $4,990

= $14,810

Discounted annual cash inflow = $14,810 x Present value annuity factor @9% for 8 years

= $14,810 x 5.535

= $81,973

So Net present value = $81,973 - $75,700

Net present value of Machine A = $6,273

Net present value of Machine B:

Initial outflow = $189,000

Net annual cash inflow = $39,800 - $10,000

= $29,800

Discounted annual cash inflow = $29,800 x Present value annuity factor @9% for 8 years

= $29,800 x 5.535

= $164,943

So Net present value = $164,943 - $189,000

Net present value of Machine B = ($24,057)