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		$77,300		$180,000
Estimated life		8 years		8 years
Salvage value		0		0
Estimated annual cash inflows		$20,200		$40,000
Estimated annual cash outflows		$4,970		$9,860

Click here to view PV 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

Which machine should be purchased?

Machine AMachine B should be purchased.

Answer 1

Answer :-

Machine A -

Net present value = Present value of annual net cash flows - Capital Investment

Present value of annual net cash flows = Annual net cash flows × PVAF(9%, 8)

Annual net cash flows = Estimated annual cash inflows - Estimated annual cash outflows

Annual net cash flows = $20,200 - $4,970 = $15,230

PVAF(9%, 8) = 5.53482

Present value of annual net cash flows = $15,230 × 5.53482

Present value of annual net cash flows = $84,295

Capital Investment = $77,300

Net present value = $84,295 - $77,300

Net present value = $6,995

Profitability index = Present value of annual net cash flow/ Capital investment

Profitability index = $84,295 / $77,300

Profitability index = 1.09

Machine B -

Net present value = Present value of annual net cash flows - Capital Investment

Present value of annual net cash flows = Annual net cash flows × PVAF(9%, 8)

Annual net cash flows = Estimated annual cash inflows - Estimated annual cash outflows

Annual net cash flows = $40,000 - $9,860 = $30,140

PVAF(9%, 8) = 5.53482

Present value of annual net cash flows = $30,140 × 5.53482

Present value of annual net cash flows = $166,819

Capital Investment = $180,000

Net present value = $166,819 - $180,000

Net present value = - $13,181

Profitability index = present value of annual net cash flow/initial investment

Profitability index = $166,819 /$180,000

Profitability Index = 0.93

Machine A should be purchased ​​​​.

Explanation :-

As machine A has positive Net present value and have higher Profitability Index than Machine B.