Question

Q1.A manufacturer is considering a purchase of a new manufacturing machine, called Machine A. Machine A is expected to save $9,000 per year and it costs $21,000 to purchase. The expected useful life of the machine is 3 years and there is no expected residual value at the end of the 3 years. The minimum acceptable rate of return is 8%.

A)What is the net present value of Machine A? (round to nearest doller, no dollar sign, use - to indicate a negative result)

B)Based on the NPV analysis, should the manufacturer purchase Machine A?
a.Yes
b.No

The manufacturer is presented with another alternative, Machine B. Machine B is expected to save $7,000 per year and it costs $16,000 to purchase. The expected useful life of the machine is 3 years and there is no expected residual value at the end of the 3 years. The minimum acceptable rate of return is 8%.

C)What is the NPV of Machine B? (round to the nearest dollar, no dollar sign, use - to indicate a negative result)

D)Based on the NPV analyses, which machine should the manufacturer purchase?
a.Machine A
b.Machine B

Answer 1

We’ll start with computing the Net Present Value of the two Machines, using the following steps.

1. Write the cash flows for years 0-3

2. Compute discount factor for each cash flow. This done by the formula 1/(1+r)ⁿ where r is the rate of interest and n is the year.

3. Calculate the Discounted cash flow by finding the product of cash flow and its corresponding discount factor.

4. Add all the discounted cash flows to calculate Net Present Value.

5. Accept the project is the NPV is positive. Further, choose the machine which has higher NPV.

Since, the NPV of Machine A is positive = $2193.87, the manufacturer should purchase machine A.

NPV of machine B = $2039.68.

Since the NPV of Machine A is greater, the manufacturer should choose machine A.