You are trying to pick the least-expensive machine for your company. You have tw
ID: 2764345 • Letter: Y
Question
You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $50,000 to purchase and which will have OCF of -$3,500 annually throughout the machine's expected life of three years; and machine B, which will cost $75,000 to purchase and which will have OCF of -$4,900 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 14 percent, which one should you choose?
Both machines A and B
Neither machine A nor B
Machine B
Machine A
Explanation / Answer
Ans.: Machine A
To choose machine there is a need to calculate present value of cash outflows .
In case of machine A
Present value of outflows is
Year . Cash outflow pvf @14% present value
0 50000. 1 -50000.
1 to 3 3500. 2.32. -8126
Total outflows -58126
In Case of machine B;
Present value of outflows is
Year . Cash outflow pvf @14% present value
0. 75000. 1. -75000
1-4 4900. 2.914. - 14277
Total outflow. -89277
Calulation of equivalent cost in case of change in no. Of years.
Machine A = present value / pvaf for 3 years
= 58126 / 2.32
= $25054
Machine B
= present value / pvaf for 4 years
= 89277 / 2.914
=$30637
Hence Machine B has more cash outflow as compared to machine A
So, machine A should be chosen.
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