Question

Cuomo Machinery Company must choose between two machines, Machine A and Machine B, and the company...

Cuomo Machinery Company must choose between two machines, Machine A and Machine B, and the company can only choose one machine. The company plans to replace the machine when it wears out on a perpetual basis, NOT for one-time use. • Machine A costs $40,000 now and will last for three years. It will require an aftertax cost of $10,000 per year after all relevant expenses. • Machine B costs $5,000 now and will last for four years. The after-tax cost of Machine B will be $20,000 per year after all relevant expenses. • All cash flows occur at the end of the year. The discount rate is 10 percent for the company. Ignore depreciation. [Note: You may use PV and PVA equations or PV and PVA tables to answer this question. However, you are required to show all detailed steps and computations clearly and make sure that the signs (positive/negative) of all cash flows are correct.]

(a) What are the net present values for Machine A and Machine B (NPVA and NPVB)?

(b) What are the equivalent annual costs for Machine A and Machine B (EACA and EACB)?

(c) Which machine (Machine A or Machine B) should the company choose? Explain your choice in one sentence.

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Answer #1

a) & b)

Machine A Machine B
Initial Cashflow -$40,000.00 -$5,000.00
Annual Cashflow -$10,000.00 -$20,000.00
Life 3 4
PV of Annual Cashflows(WN1) -$24,868.52 -$63,397.31
NPV -$64,868.52 -$68,397.31
EAC -$26,084.59 -$21,577.35

WN1: Calculation of Present Value of Cash flow:

Annuity Discount Factor of Machine A = (1-((1+0.1)^(-3)))/0.1=2.48685

PV of cashflow of Machine A = 2.48685 * 10000 = 24,868.52

Annuity Discount Factor of Machine B = (1-((1+0.1)^(-4)))/0.1 = 3.16986

PV of cashflow of Machine B = 3.169865 * 20000 = 63,397.31

c) Cuomo Machinery Company should choose Machine A, because it's NPV is more than Machine B.

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