Owens Mills Corp. is considering two mutually exclusive machines. Machine A requ

Question

Owens Mills Corp. is considering two mutually exclusive machines. Machine A requires an up-front expenditure at t = 0 of $450,000, it has an expected life of 2 years, and it will generate positive after-tax cash flows of $350,000 per year (all cash flows are realized at the end of the year) for 2 years. At the end of 2 years, the machine will have zero salvage value, but every two years the company can purchase a replacement machine with the same cost and identical cash inflows.

Alternatively, it can choose Machine B, which requires an expenditure of $1 million at t = 0, has an expected life of 4 years, and will generate positive after-tax cash flows of $350,000 per year (all cash flows are realized at year end). At the end of 4 years, Machine B will have an after-tax salvage value of $100,000.

The cost of capital is 10%. What is the net present value (on an extended 4-year life) of the better machine?
a. $157,438
b. $177,754
c. $287,552
d. $355,508
e. $500,000

Explanation / Answer

c. $287,552

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