Question

BAK Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn’t equipped to do. Estimates regarding each machine are provided below.

		Machine A		Machine B
Original cost		$76,000		$183,000
Estimated life		8 years		8 years
Salvage value		0		0
Estimated annual cash inflows		$20,000		$39,600
Estimated annual cash outflows		$5,140		$10,090

Click here to view the factor table.

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer for present value to 0 decimal places, e.g. 125 and profitability index to 2 decimal places, e.g. 10.50. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

		Machine A		Machine B
Net present value
Profitability index

Answer 1

Answer :- Calculation of Net Present Value and Profitability index of each machine : -

MACHINE A :-

Net annual cash inflow = Estimated annual cash inflows- Estimated annual cash outflows

Net annual cash inflows = $20,000 - $5,140 = $14,860

Present value of net annual cash inflow = Net annual cash inflow * PV factor (9%, 8 years)

Present value of net annual cash inflow = $14,860 * 5.53482

Present value of net annual cash inflow = $82,247

Net Present Value = Present value of net annual cash inflow - Investment cost

Net Present Value = $82,247 - $76,000 = $6,247 or $6,248

- Profitability Index = Present value of net annual cash inflow/ Investment Cost

Profitability Index = $82,247 / $76,000 = 1.08

MACHINE 2 :-

Net annual cash inflow = Estimated annual cash inflow- Estimated annual cash outflows

Net annual cash inflow = $39,600 - $10,090 = $29,510

Present value of net annual cash inflow = Net annual cash inflow * PV factor (9%,8year)

Present value of net annual cash inflow = $29,510 * 5.53482 = $163,333

Net Present Value = Present value of net annual cash inflow- Investment cost

Net Present Value = $163,333 - $183,000 = ($19,667)

- Profitability Index = $163,333 / $183,000 = 0.89

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