MKM International is seeking to purchase a new CNC machine in order to reduce co
ID: 2819241 • Letter: M
Question
MKM International is seeking to purchase a new CNC machine in order to reduce costs. Two alternative machines are in consideration. Machine 1 costs 500K, but yields a 15% savings over the current machine used. Machine 2 costs 900K but yields a 25% savings over the current machine used. In order to meet demand, the following forecasted cost information for the current machine is also provided.
Year projected cost
1 1.000.000
2 1.350.000
3 1.400.000
4 1.450.000
5 2.550.000
a) based on the NPV of the cash flows for these five years, which machine should MKM international purchase? Assume a discount rate of 12%.
Also, if MKM international lowered its required discount rate to 8%, what machine would it purchase?
Explanation / Answer
Saving in cost for both machines:
Year
Projected Cost of current machine
Saving in cost for Machine-1 @15%
Saving in cost for Machine-1 @25%
1
1,000,000
150,000
250,000
2
1,350,000
202,500
337,500
3
1,400,000
210,000
350,000
4
1,450,000
217,500
362,500
5
2,550,000
382,500
637,500
(a)
Computation of NPV if discount rate is 12%:
Machine-1
Machine-2
Year
Present Value Factor @ 12%
Cash Flow
Present Value
Cash Flow
Present Value
0
1
-500,000
-500,000
-900,000
-900,000
1
0.8929
150,000
133,935
250,000
223,225
2
0.7972
202,500
161,433
337,500
269,055
3
0.7118
210,000
149,478
350,000
249,130
4
0.6355
217,500
138,221
362,500
230,369
5
0.5674
382,500
217,031
637,500
361,718
Net Present Value (NPV)
300,098
433,497
Since NPV of Machine-2 is more than Machine-1 therefore MKM International should purchase Machine-2.
Computation of NPV if discount rate is 8%:
Machine-1
Machine-2
Year
Present Value Factor @ 8%
Cash Flow
Present Value
Cash Flow
Present Value
0
1
-500,000
-500,000
-900,000
-900,000
1
0.9259
150,000
138,885
250,000
231,475
2
0.8573
202,500
173,603
337,500
289,339
3
0.7938
210,000
166,698
350,000
277,830
4
0.7350
217,500
159,863
362,500
266,438
5
0.6806
382,500
260,330
637,500
433,883
Net Present Value (NPV)
399,379
598,965
Since NPV of Machine-2 is more than Machine-1 therefore MKM International should purchase Machine-2.
Year
Projected Cost of current machine
Saving in cost for Machine-1 @15%
Saving in cost for Machine-1 @25%
1
1,000,000
150,000
250,000
2
1,350,000
202,500
337,500
3
1,400,000
210,000
350,000
4
1,450,000
217,500
362,500
5
2,550,000
382,500
637,500
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