The MIT Whitehead Institute must choose between two DNA machines to expand their

Question

The MIT Whitehead Institute must choose between two DNA machines to expand their high-throughput genomic laboratory. Both of these machines have the same function, and the firm will choose only one vender from which to purchase their machines. The first machine, manufactured by Amersharm Pharmacia (Manchine 1) will cost $350,000. The second machine, manufactured by PE Applied Biosystem (Machine2) will cost 300,000. The cost of capital for both of these investments is 9.5 percent. The life for both machines is estimated to be five years. During this period, cash flows Machine 1 will be $ 17,000 per year, and the cash flow for Machine 2 will per year, will be $8,000 per year. These cash flows include depreciation expenses. Calculate NPV and IRR for each machine and select the best choice for the MIT Whitehead Institute.

Explanation / Answer

P.V Anniuity @9.50% Machine 1 Machine 2 (A) Amt (B) PV @ 9.50%(A X B) Amt (C) PV @ 9.50%(A X C) Cash OutFlow (E) Cost of Project - Year 0 1 $350,000 $350,000 $300,000 $300,000 Cash inflow (F) Year 1-5 3.8397        17,000                          65,275             8,000                            30,718 Year 1-5 depreciation 3.8397        70,000                       268,779          60,000                         230,382 Total Cash inflow $87,000 $334,054 $68,000 $261,100 NPV (Cash Inflow - Cash Outflow) ($15,946.10) ($38,900.40) Internal Rate of return Factor             4.02               4.41 IRR 8% 4% Internal Rate of return Factor = Investment Required / Net Annual Cash Inflow After computing the internal rate of return factor, the next step is to locate this discount factor in “present value of an annuity of $1 in arrears table”. Since the useful life of the machine is 5 years, the factor would be found in 5-period line or row. After finding this factor, see the rate of return written at the top of the column in which factor 4.02 and 4.41 is written. Conclusion: According to internal rate of return method, no proposal is acceptable because the internal rate of return promised by the proposal of both the machine is less than the minimum required rate of return (9.50%).

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