Question

U2 - 15 Your buddy in mechanical engineering has invented a money machine. The main drawback of the machine is that it is slow. It takes one year to manufacture $ 900. However, once built, the machine will last forever and will require no maintenance. The machine can be built immediately, but it will cost $ 900 to build. Your buddy wants to know if he should invest the money to construct it.

If the interest rate is 7.0 % per year, what should your buddy do?

What is your advice if the machine takes one year to build?

The NPV of the machine is $

Answer 1

1) NPV of the machine = (-)Cost of Machine + Present value of cash inflows

or, NPV = (-)$900 + ( $900 / r ) = (-)$900 + ($900 / 0.07) = $11,957.1428571 or $11,957.14

He should invest the money in the machine since the NPV is positive.

2) If it takes one year to build, then inflows will occur one year later -

NPV = (-)$900 + ($900 / 0.07) x PVIF (7%, 1) = (-)$900 + $12,857.1428571 x 0.93457943925 = $11,116.02

The advice remains the same, he should invest in the machine.