The Empire Manufacturing is considering acquisition of a new press machine for t

Question

The Empire Manufacturing is considering acquisition of a new press machine for their manufacturing facility in Pennsylvania. They have two machines from which to select. Alternative A has a cost of $120,000. The net cash flow benefit in terms of added efficiency from Alternative A amount to $65,000 per year for 3 years. Empire is also considering Alternative B which will cost $170,000. Once in operation, they project that it will produce benefits of $70,000 per year for 4 years. Inflation is expected to be zero during the next 4 years. If cash inflows occur at the end of each year, and if the cost of capital is 12%, which of the two alternatives is will add the most value? Show your calculations and work. Note that A is a 3 year project while B is a 4 year project.

Explanation / Answer

Solution:

The investment decision can be taken on the basis of NPV. To arrive at the NPV of each project, we need to sum the discounted value of cash flows for each project. The same is presented below:

As per the above analysis, it can be observed that Alternative B offers better value and should therefore be selected

Years 0 1 2 3 4 Alternative A - Cash Flow Benefit -120000 65000 65000 65000 NPV - Alt A @ 12% $32,249.14 Alternative B - Cash Flow Benefit -170000 70000 70000 70000 70000 NPV - Alt B @ 12% $38,048.62

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