Answer to Question #105469 in Finance for ray

Question

The owner of D. Donuts Ltd. wants to buy a new machine for his bakery. He is looking at two possible machines, Machine A and Machine B. On the one hand, Machine A will initially cost $ 100, its operating cost will be $ 10 per year and is expected to last 2 years. On the other hand, Machine B will cost $ 140 with an operating cost of $ 8 per year, and will run out after 3 years. Both machines will be amortized at an ACC rate of 25%. If the ERR is 10% and the tax rate is 42%, which machine should the owner buy?

Answer 1

1) By car A

Calculate cash flow by year

$Cf1=100+100\times0,42+0,25\times100+10=177$

$Cf2=10+100\times0,25=35$

$Cf3=0,25\times100=25$

$Cf4=0,25\times100=25$

Total cash flow: $262=177+35+25+25$

Calculate the discounted cash flow:

$DCf1=\frac{177} {(1+0.1)^1}=161$

$DCf2=\frac{35}{(1+0.1)^2}=29$

$DCf3=\frac{25}{(1+0.1)^3}=19$

$DCf4=\frac{25}{(1+0.1)^4}=17$

Total discounted cash flow: $226=161+29+19+17$

$NPVa=226-100=126$

2)By car B

Calculate cash flow by year

$Cf1=140+140\times0,42+0,25\times140+8=242$

$Cf2=8+140\times0,25=43$

$Cf3=8+140\times0,25=43$

$Cf4=140\times0,25=35$

Total cash flow: $363=242+43+43+35$

Calculate the discounted cash flow:

$DCf1=\frac{242}{(1+0.1)^1}=220$

$DCf2=\frac{43}{(1+0.1)^2}=36$

$DCf3=\frac{43}{(1+0.1)^3}=32$

$DCf4=\frac{35}{(1+0.1)^4}=24$

Total discounted cash flow: $220+36+32+24=312$

$NPVb=312-140=172$

NPVb more NPVa, owner buys car b