Question

Machines A and B are mutually exclusive and are expected to produce the following real cash flows:

Cash Flows ($ thousands)
Machine	C0	C1	C2	C3
A	−109	+119	+130
B	−129	+119	+130	+142

The real opportunity cost of capital is 8%.

a. Calculate the NPV of each machine. (Enter your answers in dollars not in thousands. Round your answers to the nearest whole dollar amount.)

b. Calculate the equivalent annual cash flow from each machine. (Enter your answers in dollars not in thousands. Round your answers to the nearest whole dollar amount.)

c. Which machine should you buy?

• Machine A

• Machine B

Answer 1

Qa:

NPV= present value of cashflows= sum of (cashflow/(1+r)^n)

where r=cost of capital; n=no of years ;

Machine A; NPV = -109+119/1.08+130/1.08^2 =112.64

Machine B; NPV= -129+119/1.08+130/1.08^2+142/1.08^3 = 205.36

Qb:

Equivalent annual cashflow= NPV/Annuity factor

annuity factor= [1-(1+r)^-n]/r  

Equivalent annual cashflow Machine A= 112.64/([1-(1.08)^-2]/.08) =63.165

Equivalent annual cashflow Machine B= 205.36/([1-(1.08)^-3]/.08)=79.68

Qc:

As Equivalent annual cashflow is higher for Machine B; we should purchase machine B.