Question

An apparel company is considering replacing the existing machine that produce their flagship suits. They will pick one of two machines: A and B. Machine A costs $12,000 initially(at t=0)but will provide a net cash flow (= revenue –cost) of $6,000 per year for next3years(year 1-3). Machine B costs $20,000 initially (at t=0) but will provide a net cash flow of $8,000 per year for next 5years(year 1-5). Determine which machine the company should choose and explain why. Assume a discount rate(opportunity cost of capital)of 10%for both machine.

Answer 1

To determine which machine the company should choose, calculate the net present value (NPV) of the cash flows for each machine. Machine B has a higher NPV, so the company should choose Machine B.

Step-by-step explanation:

To determine which machine the company should choose, we need to calculate the net present value (NPV) of the cash flows for each machine. The NPV formula is:

NPV = CF1 / (1 + r) + CF2 / (1 + r)2 + ... + CFn / (1 + r)n - Initial Cost

For Machine A:

NPV = $6,000 / (1 + 0.10) + $6,000 / (1 + 0.10)2 + $6,000 / (1 + 0.10)3 - $12,000 = $5,454.55

For Machine B:

NPV = $8,000 / (1 + 0.10) + $8,000 / (1 + 0.10)2 + $8,000 / (1 + 0.10)3 + $8,000 / (1 + 0.10)4 + $8,000 / (1 + 0.10)5 - $20,000

= $7,299.47

Since the NPV for Machine B is higher than Machine A, the company should choose Machine B. It provides a higher net present value of cash flows, indicating that it is more financially beneficial to choose Machine B.