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		$ 77,000		$ 188,000
Estimated life		8 years		8 years
Salvage value		0		0
Estimated annual cash inflows		$ 19,900		$ 40,200
Estimated annual cash outflows		$ 4,800		$ 9,860

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.)

Which machine should be purchased?

Answer 1

Net Present Value = Present Value of Cash Inflows – Present Value of Cash Outflows

Machine A:

NPV = (19,900-4,800)*PVAF(9%, 8 years) – 77,000

= 15,100*5.53482 - 77,000

= 6,576

Machine B:

NPV = (40,200-9,860)* PVAF(9%, 8 years) – 188,000

= 30,340*5.53482 – 188,000

=$(20,074)

Profitability Index = Present Value of Cash inflows/Present Value of Cash Outflows

Machine A:

83,576/77,000 = 1.08

Machine B:

167,926/188,000 = 0.89

Machine A should be purchased because it has positive NPV and PI is greater than 1