Question

Consider the following capital budgeting problem. The following two machines are mutually exclusive and the firm would keep reinvesting in whatever machine it buys. Machine A would be reinvested every 4 years, machine B every 3 years. The cash flows associated with each machine are tabulated as follows; all numbers are in thousand dollars; the relevant discount rate is 10% for both machines.

Year	Machine A	Machine B
0	-80	-100
1	50	60
2	50	60
3	50	60
4	25	-

A. Which of the two machines is the better investment project? Analyze the question under the assumption that whatever machine the company buys has to be reinvested in perpetuity.

B. Suppose A fits current technology, whereas machine B needs a one-time retooling for the company. These one-off installation costs would be $10,000 today. What is the optimal investment decision now?

C. Suppose the firm has an old machine in place that would serve for another two years. They can postpone investing in either machine A or B and keep using this machine. note: at each point in time one and only one machine should be producing positive cashflows. Cash flows for the old machine are:

Year	Cash Flow
1	50
2	20
3	0

D. When should they stop using the old machine?

Answer 1

Rate	10%
	Machine A	Machine B
	-80	-100
	50	60
	50	60
	50	60
NPV	$40.31	$44.74

Q1. Machine B is better investment project as it has higher NPV than Machine A as explained in above table

Q.2

Rate	10%
	Machine A	Machine B
		-10
	-80	-100
	50	60
	50	60
	50	60
NPV	$40.31	$31.58

After one time expenditure of $10000 , the NPV of machine B goes down , So now Machine A is a better option, as it has higher NPV then machine B

Q3. The company should stop using old machine in the year 3 as in the year 3 cash flow becomes 0. It is not giving any positive benefit in the year 3.