Company is deciding whether or not to invest in a new machine. New machine will

Question

Company is deciding whether or not to invest in a new machine. New machine will increase cash flow by $425,000 per year. Technology used in the machine has a 10-year life; no matter when the machine is purchased; it will be obsolete in 10 years from today. Machine is currently priced at $2,600,000. Cost will decline by $230,000 per year until it reaches $1,450,000; where it will remain. If required return is 12%, should they purchase the machine and if so, when should they purchase it?

Explanation / Answer

Every year the company with earn $425,000 with the machine. Machine has 10-year life span, but obsolete in 10 years. To figure out price of machine each year, use a formula: Total Price of Machine = Inital price of Machine - (Number of Years Past)*($230,000) Y = $2,600,000 - ($230,000 * X), where Y >= $1,450,000 If we make a table of values we find that the price of the machine is 1,450,000 at year 5. Therefore X must be in the Domain between 0 and 5 The machine must have a return of 12% or more when the machine becomes obsolete. If the machine is bought in year 0, then there is 10 working years. The equation for this would be: Profit = (S425,000 * number of years owned the machine) - (Price of machine of the Year it was bought) A simple conclusion can first be assumed: - If the price of the machine does not lower after year 5, then it is impossible for the profit to be higher after year 5 because there is less time to use the machine, but the cost is the same. Now using both sets of equations , you should be able to figure out which year gives the largest profit. An excel spreadsheet can really help with this as well. I got a return of 63% if they bought it in year 0.

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