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 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.)

Which machine should be purchased?

Machine A Machine B Original cost $74,500 $183,000 Estimated life 8 years 8 years Salvage value 0 0 Estimated annual cash inflows $20,300 $40,200 Estimated annual cash outflows $5,100 $9,810

Explanation / Answer

CALCULATION OF NPV AND PI:

Machine A should be purchased as it has a positive NPV as well as a profitability index of more than 1. So it is expected to provide more return.

DETAILS MACHINE A MACHINE B Original cost 74,500 183,000 Estimated life 8 years 8 years Salvage Value 0 0 Estimated annual Cash inflows 20,300 40,200 Less: Estimated annual cash outflows (5,100) (9,810) Annual Cash flows 15,200 30,390 * PVAF (9% for 8 years) 5.53482 5.53482 PV of cash flows 84,129 168,203 Less: Initial investment (74,500) (183,000) NPV 9,629 (14,797) *-----------*----------------*-------------* Profitability Index = PV of cash flows/ Initial investment 84,129 / 74,500 = 1.12 168,203 / 183,000 = 0.91 *-----------------*----------------------*--------------*

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