BAK Corp. is considering purchasing one of two new diagnostic machines. Either m

Question

BAK Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn’t equipped to do. Estimates regarding each machine are provided below.

Click here to view the factor table.

(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer for present value to 0 decimal places, e.g. 125 and profitability index to 2 decimal places, e.g. 10.50.)

Which machine should be purchased?

Machine A Machine B Original cost $77,880 $186,000 Estimated life 8 years 8 years Salvage value 0 0 Estimated annual cash inflows $20,070 $40,070 Estimated annual cash outflows $4,920 $9,870

Explanation / Answer

ANS

MACHINE A

PRESENT VALUE OF NET ANNUAL CASH FLOWS ($20070 - $4920)*5.53481 = $83852

PRESENT VALUE OF SALVAGE VALUE = $0 * 5.53481 = $0

CAPITAL INVESTMENT = $77880

NET PRESENT VALUE = $5972

PROFITABILITY INDEX = $83852 / $77880 = 1.08

MACHINE B

PRESENT VALUE OF NET ANNUAL CASH FLOWS ($40070 - $9870)*5.53481 = $167151

PRESENT VALUE OF SALVAGE VALUE = $0 * 5.53481 = $0

CAPITAL INVESTMENT = $186000

NET PRESENT VALUE = ($18849)

PROFITABILITY INDEX = 0.90

MACHINE B SHOULD BE REJECTED AS ITS HAS A NEGATIVE NET PRESENT VALUE AND A LOWER PROFITABLILTY INDEX. HENCE, MACHINE A SHOULD BE PURCHASED.

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