The Fernandez Company has the opportunity to invest in one of two mutually exclu

Question

The Fernandez Company has the opportunity to invest in one of two mutually exclusive machines that will produce a product that the company will need for the next 8 years. Machine A costs $10 million but will provide after-tax inflows of $4 million per year for 4 years. If Machine A is replaced, its cost will be $12 million due to inflation and its cash inflows will increase to $4.2 million due to production efficiencies. Machine B costs $15 million and will provide after-tax inflows of $3.5 million per year for 8 years. If the WACC is 10%, which machine should Fernandez acquire?

Explanation / Answer

Machine A:

PV of Cash outflows = (10000000 x 1) + (12000000 x 0.683) = $18196000

PV of cash inflows = (4000000 x 3.170) + (4200000 x 2.165) = $21773000

NPV = $3577000

Machine B:

PV of cash inflows = 3500000 x 5.335 = $18672500

NPV = 18672500 - 15000000 = $3672500

Machine B should be preferred.

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