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.
Solutions
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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