Question
In: Finance
Precision Tool is analyzing two machines to determine which one it should purchase. The company requires...
- Precision Tool is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straight-line depreciation to a zero book value over the life of its equipment. Machine A has a cost of $892,000, annual operating costs of $28,200, and a 4-year life. Machine B costs $1,118,000, has annual operating costs of $19,500, and has a 5-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should be purchased? Show all work.
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Expert Solution
We use the LCM method for comparison.This translates to 20 years
Accordingly the cash flows are
| Year | Machine A | Machine B |
| 0 | -892000 | -1118000 |
| 1 | -28200 | -19500 |
| 2 | -28200 | -19500 |
| 3 | -28200 | -19500 |
| 4 | -920200 | -19500 |
| 5 | -28200 | -1137500 |
| 6 | -28200 | -19500 |
| 7 | -28200 | -19500 |
| 8 | -920200 | -19500 |
| 9 | -28200 | -19500 |
| 10 | -28200 | -1137500 |
| 11 | -28200 | -19500 |
| 12 | -920200 | -19500 |
| 13 | -28200 | -19500 |
| 14 | -28200 | -19500 |
| 15 | -28200 | -1137500 |
| 16 | -920200 | -19500 |
| 17 | -28200 | -19500 |
| 18 | -28200 | -19500 |
| 19 | -28200 | -19500 |
| 20 | -28200 | -19500 |
Depreciation has been ignored since there is no tax rate.
NPV of each machine is
| NPV A | -2132157.98 |
| NPV B | -2209649.09 |
Hence machine A should be preferred since it has lower costs and higher NPV
WORKINGS
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