Question

A company is considering the replacement of its existing machine which is obsolete and unable to meet the rapidly rising demand for its product. The company is faced with two alternatives: (i) to buy Machine A which is similar to the existing machine or (ii) to buy Machine B which is more expensive and has greater capacity. The cash flows at the present level of operations under the two alternatives are as follows:

	0	1	2	3	4	5
Machine A (in $1000)	-26	0	6	20	15	14
Machine B (in $1000)	-40	9	15	16	17	18

The company’s cost of capital is 7%. The finance manager asks you to evaluate the machines by calculating the following: 1.Net Present Value; 2. Payback period; and 3. the IRR.

Show your calculation results to the finance manager, who is still unable to make up his mind as to which machine to recommend. What advice would you give about the proposed investment?

HINT: Use the NPV calculator linked on the left-hand side of the page.

If you use excel’s NPV function, do not forget you should include only the cash inflows (in the values line) and when you get an answer, you must deduct the cost of the machine to get the final NPV.

Answer 1