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 –108 +118 +129 B –128 +118 +129 +141 The real opportunity cost of capital is 9%. (Use PV table.) a. Calculate the NPV of each machine. (Do not round intermediate calculations. Enter your answers in thousand rounded to the nearest whole number.) Machine NPV A $ B $ b. Calculate the equivalent annual cash flow from each machine. (Do not round intermediate calculations. Round "PV Factor" to 3 decimal places. Enter your answers in thousand rounded to the nearest whole number.) Machine Cash flow A $ B $ c. Which machine should you buy? Machine A Machine B

Answer 1

(a)-Net Present Value

Net Present Value – MACHINE A

Year	Annual Cash Inflow ($)	Present Value Factor at 9%	Present Value of Annual Cash Inflow ($)
1	118	0.917	108
2	129	0.842	109
TOTAL		1.759	217

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $217 - $108

= $109

Net Present Value – MACHINE B

Year	Annual Cash Inflow ($)	Present Value Factor at 9%	Present Value of Annual Cash Inflow ($)
1	118	0.917	108
2	129	0.842	109
3	141	0.772	109
TOTAL		2.531	326

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $326 - $128

= $198

(b)- Equivalent Annual Cash Flow

Equivalent Annual Cash Flow – MACHINE A

Equivalent Annual Cash Flow = Net Present Value / [PVIFA 9%, 2 Year]

= $109 / 1.759

= $62

Equivalent Annual Cash Flow – MACHINE B

Equivalent Annual Cash Flow = Net Present Value / [PVIFA 9%, 3 Year]

= $198 / 2.531

= $78

(c)-DECISION

We should buy “MACHINE B”, since the Equivalent Annual Cash Flow of MACHINE B ($78) is greater than the Equivalent Annual Cash Flow of MACHINE A ($62)