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Purchase of Two New Machines

Wompac Company is considering the purchase of a new machine and must decide between two possible machines. The relevant data associated with each machine is shown below.
Machine A Machine B
Initial cost $275,000 $350,000
Installation cost $20,000 $30,000
Life (years) 4 7
Increase in revenues pa $180,000 $225,000
Increase in expenses pa $80,000 $140,000
Salvage value $40,000 $50,000

Ignoring all tax implications of this decision and assuming the company has a required rate of return of 10 percent, which machine should the company select?

Year Year Year Year Year
0 1 2 3 4 Required Rate Of Return 10.00%
Purchase Price ($275,000)
Initial Cost ($20,000)
Inflow $180,000 $180,000 $180,000 $180,000
OutFlow ($80,000) ($80,000) ($80,000) ($80,000)
Sale Price $40,000
Net Cash Flow ($295,000) $100,000 $100,000 $100,000 $140,000
1.1 1.21 1.331 1.4641
PV Cash Flow ($295,000) $90,909 $82,645 $75,131 $95,622

NPV 49,307

Year Year Year Year Year
0 1 2 3 4 5 6 7
Purchase Price ($350,000)
Initial Cost ($30,000)
Inflow $225,000 $225,000 $225,000 $225,000 $225,000 $225,000 $225,000
OutFlow ($140,000) ($80,000) ($80,000) ($80,000) ($80,000) ($80,000) ($80,000)
Sale Price 140000
Net Cash Flow ($380,000) $85,000 $145,000 $145,000 $145,000 $145,000 $145,000 $285,000
1.1 1.21 1.331 1.4641 1.61051 1.771561 1.9487171
PV Cash Flow ($380,000) $77,273 $119,835 $108,941 $99,037 $90,034 $81,849 $146,250

NPV 115,119

These projects are not comparable because they have different lives. If project A
is accepted (project life = 4 years), at its termination the firm could replace the
machine and receive additional benefits whereas acceptance of project B (project
life = 7 years) would exclude this possibility.

Replacement chains:?

Solution Summary

The solution discusses the purchase of two new machines.

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