Question

2. Suppose you have to decide between two alternative machines (or two alternative maintenance policies). The investment at t=0 for each of them is $90 million. Machine A will last for 6 years and will generate annual cash flows of $60 million every year from t=1 to t=6, while Machine B will last for 9 years and will generate annual cash flows of $45 million every year from t=1 to t=9.

Given a discount rate of 7.5% per year, work out the NPV (Net Present Value) of each machine, and state which machine is more attractive financially (a) without future replacement, and (b) with future replacement.

Answer 1

Solution :-

NPV of Machine A = $60 * PVAF ( 7.5% , 6 ) - $90

= ( $60 * 4.694 ) - $90

= $281.63 - $80

= $191.63 million

NPV of Machine B = $45 * PVAF ( 7.5% , 9 ) - $90

= ( $60 * 4.694 ) - $90

= $287.05 - $90

= $197.05 million

(a) In case of , without future replacement

Accept Machine B

(b) In case with future Replacement

Annual Worth of Machine A = $191.63 / PVAF ( 7.5% , 6 )

= $191.63 / 4.694

= $40.826

Annual Worth of Machine B = $197.05 / PVAF ( 7.5% , 9 )

= $197.05 / 6.379

= $30.89

In this case , Accept Machine A

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