Question

Dylan and Co. is analyzing two machines to determine which one it should purchase. The company requires a 14% rate of return, has a 40% marginal tax rate, and uses straight-line depreciation to a zero book value, which is the expected salvage value after their lives. Machine A has a cost of $310,000, annual operating costs of $20,000, and a 4-year life. Machine B costs $210,000, has annual operating costs of $60,000, and has a 3-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should it purchase and why? (3 points)

Answer 1

Mchine-A:
Annual Operating cost			20,000
Tax benefit on cost @40%			-8000
Net cost operating			12,000
Tax benefit on dep			31,000
(310,000/4)*40%
Annual Net savings			19,000
Annuity factor for 3 yrs at 14%			2.3216
Present value of cash inflows			44,110
Less: Initial Investment			310,000
Net Cash outflows			-265,890
Annuity f actor			2.3216
Annualised cash flows			-114529
Machine-B
Annual Operating cost			60,000
Tax benefit on cost @40%			-24000
Net cost operating			36,000
Tax benefit on dep			28,000
(210,000/3)*40%
Annual Cost net			-8,000
Annuity factor for 3 yrs at 14%			2.9137
Present value of cash outflows			-23,310
Add; Investment			-210,000
Net Cash outflows			-233,310
Annuity f actor			2.9137
Annualised cash flows			-80073.4
Machine-B shall purchase as it annualized cost is lesser.