Question

Question 1: A company needs to purchase a new machine to produce parts. There are two options.

Alternative A costs $75,000 with a maintenance cost of $2,000 per quarter. The revenue generated from the machine is $2,000 every month. The life of the machine is expected to be 20 years. At the end of twenty years, the machine should be worth no more than 10% of its cost.

Alternative B costs $50,000 with a maintenance cost of $1,000 per quarter. This machine will generate $1,500 in revenue every month. However, the life of the machine is only 10 years. At the end of 10 years, the machine should be worth no more than 8% of its cost.

Create the cash flow for both opportunities. Hint: The alternatives are mutually exclusive and have different lives. How should the cash flow be drawn to find an equal life for both?

Answer 1

​​​​​​1)

By calculating internal rate of return alternative 1 looks good. Because it requires only return of 21.05%to get break even. But alternative 2 requires 25.43%of return to get break even.

2) To have equal life's consider buying again a ten years life machine again at end of 10th year.