You need a new piece of equipment to replace a machine that just blew up. You...

You need a new piece of equipment to replace a machine that just blew up. You have been presented with 2 choices. Equipment X costs $10,000 and has an expected 3 year life – savings are estimated at: $6,000, $4,000 and $3,000 for the 3 years, respectively. Equipment Z costs $20,000 and has a residual value at the end of 3 years of 30% of its original cost. Z’s cost savings are estimated at $6,000, $7,000 and $8,000 for 3 years, respectively.

Calculate the net present value of each of these options (cost of capital is 12%).
Which option would you support… consider all factors and measures including DCF, IRR, profitability index and payback.

Solutions

Expert Solution

To Know which project to choose it is important to consider many factors mentioned:

1. NPV = PV of future cashflows of inverstment - initial investment

PV of cashflows = Cash inflow of year 1 * PVIF of 12% of 1 year + Cash inflow of year 2 * PVIF of 12% of 2 year + Cash inflow of year 3 * PVIF of 12% of 3 year

2. Discounted cashflows is equal to sum of PV of all the future cashflows.

3. IRR = '= IRR(all the inflows including initial investment) in excel

4. Profitability Index = DCF / initial investment

5. Payback period: is in how much time the initial investment is recovered

ekkarill92 answered 1 year ago

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