Question

Suppose company Sith AB must choose between two lightsaber production machines. Machine A costs less than machine B but will not last as long. The cash outflows from the two machines are shown here:

Machine	Date
	0 (€)	1 (€)	2 (€)	3 (€)
A	500	125	125
B	600	100	100	100

Machine A costs €500 and lasts 2 years. There will be maintenance expenses of €125 to be paid at the end of each of the 2 years. Machine B costs €600 and lasts 3 years. There will be maintenance expenses of €100 to be paid at the end of each of the 3 years. The market discount rate is 10%.

Which machine should be chosen and why? Please show all steps of your work.

Answer 1

Computation of Net Present Value of Machine A

Year	Cash outflow( Euro)	Disc @ 10%	Discounted Cash flows( Euro)
0	500	1	500.0000
1	125	0.909091	113.6364
2	125	0.826446	103.3058
	Total		716.9421

Computation of Net Present Value of Machine B

Year	Cash outflow( Euro)	Disc @ 10%	Discounted Cash flows( Euro)
0	600	1	600.0000
1	100	0.909091	90.9091
2	100	0.826446	82.6446
3	100	0.751315	75.1315
	Total		848.6852

Since the Machinaries have different span life, it is not possible to take the correct decision using Present worth analysis.

We can take the Decision by using Equivalent Annual Cost Analysis.

EAC A = NPV / Annuity Factor

= 716.9421/ PVAF( 10%,2)

= 716.9421/1.73554

= 413.0945 Euros

So the Equvalent Annual Cost of Machinary A is -413.095 Euros.

EAC B = NPV / Annuity Factor

= 848.6852/ PVAF( 10%,3)

= 848.6852/2.48685

=341.2692 Euro

So the Equvalent Annual Cost of Machinary B is -341.269 Euros.

Decision : Since EAC for Machine B is lower, it is better to invest in Machine B.