Question

Evans Industries wishes to select the best of three possible machines, each of which is expected to satisfy the firm’s ongoing need for additional aluminum-extrusion capacity. The three machines – A, B, and C – are equally risky. The firm plans to use a 12% cost of capital to evaluate each of them. The initial investment and annual cash inflows over the life of each machine are shown in the following table:

	Machine A	Machine B	Machine C
Initial investment	-$92,000	-$65,000	-$100,500
Year (t)	Cash Flows	Cash Flows	Cash Flows
1	12,000	10,000	30,000
2	12,000	20,000	30,000
3	12,000	30,000	30,000
4	12,000	40,000	30,000
5	12,000	----------	30,000
6	12,000	----------	---------

a.) Calculate the NPV for each machine over its life. Rank the machines in descending order on the basis of NPV.

b.) Use the annualized net present value (ANPV) approach to evaluate and rank the machines in descending order on the basis of ANPV.

c.) Compare and contrast your findings in parts a and b. Which machine would you recommend that the firm acquire? Why?

Answer 1

a) Statement showing NPV

	Machine A			Machine B			Machine C
Year	Cash Flow	PVIF @12%	PV = Cash flow*PVIF	Cash Flow	PVIF @12%	PV = Cash flow*PVIF	Cash Flow	PVIF @12%	PV = Cash flow*PVIF
0	-92000	1	-92000	-65000	1	-65000	-100500	1	-100500
1	12000	0.8929	10714	10000	0.8929	8929	30000	0.8929	26786
2	12000	0.7972	9566	20000	0.7972	15944	30000	0.7972	23916
3	12000	0.7118	8541	30000	0.7118	21353	30000	0.7118	21353
4	12000	0.6355	7626	40000	0.6355	25421	30000	0.6355	19066
5	12000	0.5674	6809				30000	0.5674	17023
6	12000	0.5066	6080
NPV			-42663			6647			7643
Rank			3			2			1

Since NPV of Machine C is high it should be selected

b) Statement showing Annualized NPV

Particulars	Machine A	Machine B	Machine C
NPV	-42663	6647	7643
PVIFA(12%,6years)	4.1114
PVIFA(12%,4years)		3.0373
PVIFA(12%,5years)			3.6048
Annualized net present value =NPV/PVIFA	-10377	2188	2120
Rank	3	1	2

Here machine B should be selected

C) When project have different life then it becomes difficult to evaluate project on basis of NPV only. In such case it is important to check what the project is derieving annually . Thus machine B should be selected