Question

Maryville Cleaners has the opportunity to invest in one of two dry cleaning machines.  Machine A has a four-year expected life and a cost of $40,000.  It will cost an additional $10,000 to have the machine delivered and installed, and the expected residual value at the end of four years is $2,000.  Machine B has a four-year expected life and a cost of $60,000.  It will cost an additional $15,000 to have machine delivered and installed, and the expected residual value at the end of four years is $5,000.  The company has a required rate of return of 10 percent.  Additional cash flows related to the machines are as follows:

Machine A

Item	Year 1	Year 2	Year 3	Year 4
Labor savings	$10,000	$15,000	$20,000	$25,000
Power savings	1,500	1,500	1,500	1,500
Chemical savings	3,000	3,000	3,000	3,000
Additional maintenance costs	(1,200)	(1,200)	(1,200)	(1,200)
Additional miscellaneous costs	(2,500)	(2,500)	(2,500)	(2,500)

Machine B

Item	Year 1	Year 2	Year 3	Year 4
Labor savings	$20,000	$25,000	$30,000	$35,000
Power savings	2,000	2,000	2,000	2,000
Chemical savings	3,500	3,500	3,500	3,500
Additional maintenance costs	(1,500)	(1,500)	(1,500)	(1,500)
Additional miscellaneous costs	(3,000)	(3,000)	(3,000)	(3,000)

Required

1. Compute the payback period for each of the two machines.
2. Compute the net present value for each of the two machines.
3. Determine the internal rate of return for each of the two machines.
4. Which machine purchase do you recommend that the company pursue based on the results of your calculations?

Answer 1

Answer with working is given below