Question

A Malaysian firm has to choose between two new machines.

Machine A would cost $80,000 and is expected to have an economic life of four years. It should generate $50,000 of revenue each year, and incur costs of $22,000 a year.

Machine B will cost $100,000 and is expected to have an economic life of five years. It is anticipated that it will produce annual revenue of $51,000 and attract costs of

$22,000 a year.

If the firm requires a return of 10% on their investment and the company tax rate is 30%, which machine should be chosen?

Answer 1

Machine A
	Year 0	Year 1	Year 2	Year 3	Year 4
Purchase Price	(80,000)
Revenue		50,000	50,000	50,000	50,000
Operating Costs		(22,000)	(22,000)	(22,000)	(22,000)
Profit before tax		28,000	28,000	28,000	28,000
Tax @ 30%		(8,400)	(8,400)	(8,400)	(8,400)
Profit After Tax		19,600	19,600	19,600	19,600
Discounting Factor		0.91	0.83	0.75	0.68
Discounted Cash Flow		17,818	16,198	14,726	13,387
NPV					(17,871)

Machine B
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Purchase Price	(100,000)
Revenue		51,000	51,000	51,000	51,000	51,000
Operating Costs		(22,000)	(22,000)	(22,000)	(22,000)	(22,000)
Profit before tax		29,000	29,000	29,000	29,000	29,000
Tax @ 30%		(8,700)	(8,700)	(8,700)	(8,700)	(8,700)
Profit After Tax		20,300	20,300	20,300	20,300	20,300
Discounting Factor		0.91	0.83	0.75	0.68	0.62
Discounted Cash Flow		18,455	16,777	15,252	13,865	12,605
NPV						(23,047)

Equivalent Annuity Approach = (r * NPV)/[1-(1+r)-n]

Machine A = [0.1 * (17,871)]/[1-(1.1)-4]
= (1787.1)/0.316986545
Machine A = (5,637.66)

Machine B = [0.1 * (23,047)]/[1-(1.1)-5]
= (2304.7)/0.379078677
Machine B = (6,079.75)

Since EAA of Machine A is less than Machine B. Hence, we should go for Machine A.