Question

BAK Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn’t equipped to do. Estimates regarding each machine are provided below.

		Machine A		Machine B
Original cost		$75,700		$189,000
Estimated life		8 years		8 years
Salvage value		0		0
Estimated annual cash inflows		$19,800		$39,800
Estimated annual cash outflows		$4,990		$10,100

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate.

Answer 1

NPV = PV of future cash flows – Initial investment

Profitability Index = PV of future cash flows/Initial investment

Machine A:

NPV = ($ 19,800 - $ 4,990) x PVIFA (9 %, 8) - $ 75,700

         = $ 14,810 x 5.53482 - $ 75,700

         = $ 81,970.6842 - $ 75,700

         = $ 6,270.6842 or $ 6,270.68

Profitability Index = $ 81,970.6842/ $ 75,700

                               = 1.082835987 or 1.08

Machine B:

NPV = ($ 39,800 - $ 10,100) x PVIFA (9 %, 8) - $ 189,000

        = $ 29,700 x 5.53482 - $ 189,000

            = $ 164,384.154 - $ 189,000

             = - $ 24,615.846 or - $ 24,615.85

Profitability Index = $ 164,384.154 /$ 189,000

                             = 0.869757429 or 0.87

Machine A is preferable as it has positive NPV and PI is greater than 1.