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Precision Tool is analyzing two machines to determine which one it should purchase. The company requires...

  1. 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

jeff jeffy answered 2 years ago
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