KSU Corp is considering purchasing one of the two new diagnostic machines. Eithe
ID: 2496917 • Letter: K
Question
KSU Corp is considering purchasing one of the two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it current l isn't equipped to do. Estimates regarding each machine are provided below: Instructions: Calculate the following for each machine. Payback period Net present value Profitability index Assume a 9% discount rate. Which machine should be purchased? The following factors may be needed in computing present value: Present value of $1 at 9% for 8 years: .50187 Present value of an annuity of $1 at 9% for 8 years: 5.53482Explanation / Answer
Machine A:
Original cost: $ 106000
Estimated net cash flows per year: $20000
Pay back period
= Initial investment / Net cash flow per year
= $106000 / $20000
= (100000 / 20000) + (6000 / 20000)*12 months
= 5 years and 3.6 months
NPV
= PV of cash inflows - PV of cash outflow
= $20000 * PVIFA (9%, 8) - initial investment
= $20000 * 5.53482 - $106000
= $110696.40 - $106000
= $4696.40
Profitability Index
= PV of cash inflows / Initial investment
= $110696.40 / $106000
= 1.044305
Machine B:
Original cost: $ 175000
Estimated net cash flows per year: $30000
Pay back period
= Initial investment / Net cash flow per year
= $175000 / $30000
= (150000 / 30000) + (25000 / 30000)*12 months
= 5 years and 10 months
NPV
= PV of cash inflows - PV of cash outflow
= $30000 * PVIFA (9%, 8) - initial investment
= $30000 * 5.53482 - $175000
= $166044.60 - $175000
= ( $ 8955.40)
Profitability Index
= PV of cash inflows / Initial investment
= $166044.60 / $175000
= 0.94883
Recommendation:
Machine A should be purchased as it has a positive NPV and a profitability index greater than 1. Machine B should be rejected as NPV of machine B is neagative and the profitability index is less than 1,
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