A company is considering two types of machines for a manufacturing process. Mach

Question

A company is considering two types of machines for a manufacturing process. Machine A has an immediate cost of $82,000, and its salvage value at the end of 8 years of service life is $16,000. The operating costs of this machine are estimated to be $3000 per year. Extra income taxes are estimated at $2100 per year. Machine B has an immediate cost of $30,000, and its salvage value at the end of 8 years' service is neglible. The annual operating costs for Machine B will be $9,000. There are no extra income taxes with Machine B. Compare these two mutually exclusive alternatives by the present-worth method at i = 12.1%. Enter the ."net present cost" as a positive number for the machine that you would select. You must select one of the two machines."

Explanation / Answer

Answer

As both alternatives have the same life span i.e. 8years, the present worth of the alternatives will be compared over a period of 8 years.

NPV Outflow of machine A

NPV Outflow of Machine A = 82,000 + 5100(P/A, i, n) - 16000(P/F, i, n)

=  82,000 + 5100(P/A, 12.1, 8) - 16000(P/F, 12.1, 8)
= 82000 + 25247 - 6416

= $ 100381

NPV of Machine B

=  30,000 + 9000(P/A, i, n)

=  30,000 + 9000(P/A, 12.1, 9)
= 30000+ 44553

= $ 74553

As the cost is lower in Machine B and hence Machine B should be selected

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