Question

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Justin Manufacturing is considering purchasing two machines. Each machine costs $9,000 and will produce cash flows as follows:

End of                        Machine A               Machine B

Year

1                                  $5,000             $1,000

2                                  $4,000             $2,000

3                                  $3,000             $12,000

Justin Manufacturing uses the net present value method to make the decision, and it requires a 15% annual return on its investments. The present value factors of 1 at 15% are: 1 year, 0.8696; 2 years, 0.7561; 3 years, 0.6575. Which machine should Justin purchase and why? Hint: This is a two-part question. Part 1. Make sure you calculate the NPV for both machines and Part 2. Which machine should the company invest in and why?

Answer 1

Part 1.

MACHINE A

Net Present Value = Present Value of Cash flows – Initial Investment

= [($5000 x 0.8696) + ( $4000 x 0.7661) + ($3000 x 0.6575) ] - $9000

= $4348 + $3024.40 + $1972.5 - $9000

= $344.5

Net Present Value - MACHINE A = $344.5

MACHINE B

Net Present Value = Present Value of Cash flows – Initial Investment

= [($1000 x 0.8696) + ( $2000 x 0.7661) + ($12000 x 0.6575) ] - $9000

= $869.6 + $1512.2 + $7890 - $9000

= $1271.8

Net Present Value - MACHINE A = $1271.8

Part 2. Which machine should the company invest in and why ?

Justin should make investment in Machine B, Since it has a higher NPV of $1271.8