Question

Esquire Company needs to acquire a molding machine to be used in its manufacturing process. Two types of machines that would be appropriate are presently on the market. The company has determined the following: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Machine A could be purchased for $66,000. It will last 10 years with annual maintenance costs of $2,300 per year. After 10 years the machine can be sold for $6,930.

Machine B could be purchased for $60,000. It also will last 10 years and will require maintenance costs of $9,200 in year three, $11,500 in year six, and $13,800 in year eight. After 10 years, the machine will have no salvage value.

Required:
Assume an interest rate of 8% properly reflects the time value of money in this situation and that maintenance costs are paid at the end of each year. Ignore income tax considerations.

Calculate the present value of Machine A & Machine B. Which machine Esquire should purchase? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your final answers to nearest whole dollar amount.)
  

Answer 1

Please note that discounting factor at 8% are as follows as per present value table:

Year - 1 = 0.9259

Year - 2 = 0.8573

Year - 3 = 0.7938

Year - 4 = 0.7350

Year - 5 = 0.6806

Year - 6 = 0.6302

Year - 7 = 0.5835

Year - 8 = 0.5403

Year - 9 = 0.5002

Year - 10 = 0.4632

With reference the above question please note the following:

Net Present Value (NPV)

A discounted cash flow measure to evaluate the viability of an investment proposal. It serves to determine whether the present value of estimated cash flow exceeds the investment on a project. The Net Present Value is the difference of the sum of discounted cash flows and the outlay.

NPV of cash flow = Present value of all future cash inflows over the life of the project (-) Present value of cash out flow.

Machine – A

a) Machine could be purchased for $66,000 (Cash Outflow).

b) It will last 10 years.

c) Annual maintenance costs of $2,300 per year (Cash Outflow).

d) After 10 years the machine can be sold for $6,930 (Cash Inflow).

i) From the above the Present value cash outflows = $66,000 X 1 + $2,300 X 0.9259 + $2,300 X 0.8573 + $2,300 X 0.7938 + $2,300 X 0.7350 + $2,300 X 0.6806 + $2,300 X 0.6302 + $2,300 X 0.5835 + $2,300 X 0.5403 + $2,300 X 0.5002 + $2,300 X 0.4632 = $81,433

ii) From the above the Present value of cash inflow = $6,930 X 0.4632 = $3,210

iii) Hence, NPV = $3,210 (-) $81,433 = (-) $78,223

Machine – B

a) Machine could be purchased for $60,000 (Cash Outflow).

b) It will last 10 years.

c) The machine will require maintenance costs of $9,200 in year three, $11,500 in year six, and $13,800 in year eight (Cash Outflow).

d) After 10 years the machine will have no salvage value (Nil Cash inflow).

i) From the above the Present value of cash outflow = $60,000 X 1 + $9,200 X 0.7938 + $11,500 X 0.6302 + $13,800 X 0.5403 = $82,006

ii) From the above the Present value of cash inflow = Nil

iii) Hence, NPV = (-) $82,006

Hence, from the above it can be concluded that Esquire should purchase “Machine A”.