Exercise 24-4 BAK Corp. is considering purchasing one of two new diagnostic mach

Question

Exercise 24-4 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. Machine A $74,600 8 years Original cost Estimated life Salvage value Estimated annual cash inflows Estimated annual cash outflows Machine B $182,000 8 years 0 $40,200 $10,190 $20,000 $5,170 Click here to view PV table 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. For calculation purposes, use 5 decimal places as displayed in the factor table provided) Machine A Machine B Net present value Profitability index Which machine should be purchased? should be purchased

Explanation / Answer

Machine A Machine B Net Present Value $ 7,481 $ -15,900 Profitability Index             1.10             0.91 Machine A should be purchased. Machine A has positive net present value and profitability index of more than 1. This shows that it is better to purchase Machine A. Working: a. Calculation of annual net cash inflows: Machine A Machine B Annual cash inflwos        20,000        40,200 Less annual cash outflows           5,170        10,190 annual net cash inflows        14,830        30,010 b. Present Value of annuity of 1 = (1-(1+i)^-n)/i Where, = (1-(1+0.09)^-8)/0.09 i 9% =    5.53482 n 8 c. Machine A Machine B Annual net cash inflows        14,830            30,010 Present value of annuity of 1      5.53482          5.53482 Present value of annual cash inflows        82,081        1,66,100 Less original cost        74,600        1,82,000 Net Present Value           7,481          -15,900 d. Machine A Machine B Present value of annual cash inflows        82,081        1,66,100 / Original cost        74,600        1,82,000 Profitability Index             1.10                 0.91

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