Question

The MIT Whitehead Institute must choose between two cDNA microarray machines to expand their high-throughput genomic laboratory. Both of these machines have the same function, and the firm will only choose one vendor from which to purchase their machines.

The first machine, manufactured by Amersham Pharmacia (machine 1), will cost $350,000. The second machine, manufactured by PE Applied Biosystems (machine 2), will cost $300,000.

The cost of capital for both of these investments is 9.5%. The life for both machines is estimated to be 5 years. During this period, cash flows for machine 1 will be $17,000 per year and cash flows for machine 2 will be $8,000 per year. These cash flows include depreciation expenses.

Calculate the NPV and IRR for each machine using MS Excel. Then, select the best choice for the MIT Whitehead Institute. Under your analysis, briefly explain the reasoning for your decision and how it might impact operations over the next five years

Answer 1

Machine-1:

Annual Deprecation on Machine – 1 = 350,000/5 = $70,000

Annual Cash Flows for Machine-1 = Cash Flows including Depreciation + Depreciation

= 17,000 + 70,000

= $87,000

Calculation of NPV of Machine-1:

Machine-1:
Year	Cash Flows	DF Working	Discounting Factor @ 9.3%	Present Value (Cash Flows*DF)
0	(350,000)	1	1	(350,000.00)
1	87,000	1/1.095^1	0.913242009	79,452.05
2	87,000	1/1.095^1	0.834010967	72,558.95
3	87,000	1/1.095^1	0.761653851	66,263.89
4	87,000	1/1.095^1	0.695574293	60,514.96
5	87,000	1/1.095^1	0.635227665	55,264.81
			NPV of Machine-1:	(15,945.34)

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Calculation of IRR of Machine-1:

At IRR,

Initial Investment = Present Value of Cash Inflows

Let IRR for Machine-1 be “x%”

At IRR,

350,000 = 87,000(1+x)^1 + 87,000(1+x)^2 + 87,000(1+x)^3 + 87,000(1+x)^4 + 87,000(1+x)^5

Computing for x,

We get x = 7.714%

Therefore, IRR of Machine – 1 is 7.714%

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Machine-2:

Annual Deprecation on Machine – 2 = 300,000/5 = $60,000

Annual Cash Flows for Machine-1 = Cash Flows including Depreciation + Depreciation

= 8,000 + 60,000

= $68,000

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Calculation of NPV of Machine-2:

Machine-2:
Year	Cash Flows	DF Working	Discounting Factor @ 9.3%	Present Value (Cash Flows*DF)
0	(300,000)	1	1	(300,000.00)
1	68,000	1/1.095^1	0.913242009	62,100.46
2	68,000	1/1.095^1	0.834010967	56,712.75
3	68,000	1/1.095^1	0.761653851	51,792.46
4	68,000	1/1.095^1	0.695574293	47,299.05
5	68,000	1/1.095^1	0.635227665	43,195.48
			NPV of Machine-2:	(38,899.80)

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Calculation of IRR of Machine-2:

At IRR,

Initial Investment = Present Value of Cash Inflows

Let IRR for Machine-2 be “y%”

At IRR,

300,000 = 68,000(1+y)^1 + 68,000(1+y)^2 + 68,000(1+y)^3 + 68,000(1+y)^4 + 68,000(1+y)^5

Computing for y,

We get y = 4.323%

Therefore, IRR of Machine – 2 is 4.323%

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Analysis and Conclusion:

Best choice for  MIT Whitehead Institute is Machine-1 since it has Higher IRR as compared to Machine-2 although it is less than the cost of capital of the entity.

If compared to Cost of Capital , MIT Whitehead Institute should not invest in either of he machines , since it has negative NPV and IRR of both machines are less than the cost of capital of MIT Whitehead Institute.

But if company has to invest in either of the machines and has no other option , then it must choose and invest in Machine-2.