Question

Long Memorial Hospital is deciding between purchasing one of two ventilator machines for its ICU. Machine A costs $65,000. Its annual maintenance and repairs will amount to $5,000 for each of the first five years and $7,000 for each of the next ten years. After 15 years, the machine will be scrapped. Machine B costs $45,000, has the life expectancy of 10 years and will cost $5000 per year to maintain and repair. Using 8% discount rate on its investments, which machine should Long Memorial Hospital choose?

Answer 1

Based on the given data, pls find below steps, workings and answers:

Need to evaluate the NPV of these two options, separately; Once the NPV is identified, the Equivalent Annual cost to be arrived to assess the annual cost, since these projects have different life periods. The formula for the Equivalent Annual Cost is given in the workings below;

Based on the NPV of the Projects and based on the Equivalent Annual Costs (EAC) of the projects, Mahcine B has lower negative NPV and lower EAC; Hence, the hospital should choose Machine B.

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;