Question

An apparel company is considering replacing the existing AC system. They will pick one of two systems: A and B. System A costs $12,000 initially (at t=0) and will result in bills of $10,000 per year for next 3 years (year 1-3). System B costs $20,000 initially (at t=0) and will result in bills of $8,000 per year for next 5 years (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) for each system using the discount rate of 10%. Compare the NPV values to determine the better choice.

Step-by-step explanation:

To determine which machine the apparel company should choose, we need to calculate the net present value (NPV) of each machine. The NPV takes into account the initial cost and future cash flows, discounted at the given discount rate of 10%. For System A, the NPV can be calculated as follows:

NPV = -12000 + (10000/(1+0.1)^1) + (10000/(1+0.1)^2) + (10000/(1+0.1)^3)

For System B, the NPV can be calculated as follows:

NPV = -20000 + (8000/(1+0.1)^1) + (8000/(1+0.1)^2) + (8000/(1+0.1)^3) + (8000/(1+0.1)^4) + (8000/(1+0.1)^5)

After calculating the NPV for both systems, we can compare the values. The machine with the higher NPV would be the better choice for the company.