Answer to Question #117971 in Financial Math for cassandra

Question

A company is considering buying either machine A or machine B for its business.The cost of machine A is GHS90,000 and that for machine B GHS105,000. Both machines have a salvage value of zero at the end of their respective economic life (5 years for machine A and 4 years for machine B). Cash inflow from machine A is as follows; GHS20000, GHS22500, GHS31000, GHS40500 and GHS46000 for year 1,2,3,4 and 5, respectively. Cash inflow from machine B is GHS30,000 in year 1, GHS49,000 in year 2, GHS50,500 in year 3 and GHS35,000 in year 4. Machine A will require servicing in year 2 and 3, which will cost the company GHS6500 per each of the service years. Machine B will require servicing in year 2 and 3, which will cost the company GHS7000 per year for each of the servicing years. Based on the Annual Worth criteria and interest rate of 15%, which machine would you recommend to the company and at what Annual Worth?

Answer 1

Calculate NPV for each machine:

MACHINE A

Year      cashflow    *     pvif           =         Present value

1             20000                   0.8696                  17392

2             22500                   0.7561                  17012.25              

3             31000                   0.675                    20382.50

4             40500                   0.5718                  23157.90            

5             46000                   0.4992                  22871.20

Total present value 100815.85

                                                                                                                                                         Less cost of repairs

Year 2   6500         *        0.7561      =         (4914.65)

Year 3   6500         *        0.6575      =         (4273.75)

Less initial cost of machine A         =         (90000)

Net Present Value   (machine A)        =         1627.45

MACHINE B

Year      cashflow    *      pvif           =       Present value

1             30000               0.8696                  26088

2             49000             0.7561                  37048.9

3             50500             0.675                    33203.75

4             35000                0.5718                  20013

               

                                                                               

Total present value                                        116353.65

Cost of repairs

Year 2   7000         *        0.7561      =   (5292.70)

Year 3   7000         *        0.6575      =         (4602.50)

Less initial cost of machine B         =        (105000)

Net Present Value  (machine B)       =        1458.45

would recommend Machine A because it has a higher annual worth(NPV)

Annual worth of machine A is 1627.45