Question

A company is considering buying either Machine A or Machine B. Machine Both machines cost $46,629, but Machine A is expected to last 4 years and generate cash flows of $19,528 each year, while Machine B is only expected to last 2 years, but generate cash flows of $34,711 each year. If the WACC is 10%, which machine is the best investment? Calculate the RELEVANT NPV of each investment project, then obtain the difference. That is, enter the NPV of buying Machine A - the NPV of buying Machine B. Hint: remember that the NPVs of projects of different lengths are not directly comparable... Round to the nearest dollar (no decimals).

Answer 1

NPV of machine A= -Initial cost + PV of cash inflows

= -46629+ Cash inflow*(1-1/(1+r)^n)/r

= -46629+ 19528*(1-1/(1+10%)^4)/10%

= -46629+ 61901.13

= 15272.13

Cash flows of Machine B- Assuming the machine will be bought again in Year 2 to make the lives equal to 4 years

Year 0= -46629

Year 1= 34711

Year 2= 34711-46629 = -11918

Year 3= 34711

Year 4= 34711

NPV= C0+ CF1/(1+r)^1 + CF2/(1+r)^2 …………CFn/(1+r)^n

= -46629+34711/1.1^1-11918/1.1^2+ 34711/1.1^3+34711/1.1^4

= 24863.84

Difference= NPV of buying Machine A - the NPV of buying Machine B

= 15272.13- 24863.84

= -9591.71

Buying the machine B is better since it has a higher NPV.