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Calculating net investment, net cash flows and net present value

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1. Find the Net Investment for both options. Which option is more attractive based solely on this evaluation?
2. Calculate the Net Cash Flows for both options. Which option is more attractive based solely on this evaluation?
3. Briefly explain the reasons for any difference in your answer in question 1 and question 2 or why both support the same option.
4. Find the Net Present Value of each investment.
5. Which investment would Bob most likely recommend given his recommendation to use the Net Present Value method? Why?
6. Why would Bob tell Joe and Mary not to base their comparison on the future values of the cash flows, as they were intuitively doing before they went to see him?

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This solution helps with a finance problem. Concepts discussed include net investment, net cash flows and net present value.

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Posting ID: 38075 Business, Finance Year 4
Bid Credits: 9 Deadline: April 15, 2005, 5:20 am EDT

Joe and Mary are a married couple who own their own business. Over the past several years they have grown their business from an idea that they had into a successful moneymaker. When the couple began their business they did not have a great deal of capital to invest in it and as a result some of the equipment that they purchased was only useful to them in the short run. One such piece of equipment is the DLT-35 machine used to make their primary product. The DLT-35 machine that they have is still in good working order but can not produce the volume that is needed to match sales. In addition the model of the machine that they have is more expensive to operate than newer models of the machine because it is less efficient then they are. This machine was originally purchased for $500,000 and has incurred $275,000 in depreciation.

After lengthy consideration the couple decided to replace the DLT-35 machine. They have done some research for this expenditure and found that they could purchase either one of two machines. Both machines are sold by the same dealer who has offered them $750,000 in trade-in value on the current DLT-35 machine. The dealer also has a special promotion going on that waives all installation costs for either machine.
The first option, option 1, is to buy a DLT-1000 machine. The DLT-1000 has a sales price of $2 million. This machine is an updated version of the one that they have. Although the machine is similar it is believed that Joe and Mary's employees will have difficulty using the machine at first. The manufacturer has guaranteed that this machine will increase Joe and Mary's EBTD by $100,000 in the first year, $125,000 in the second year, $250,000 in the ...

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