Question

Renegade Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3.1 million and will last for six years. Variable costs are 34% of sales, and fixed costs are $1,946,634 per year. Machine B costs $5.1 million and will last for nine years. Variable costs for this machine are 23% of sales and fixed costs are $1,361,902 per year. The sales for each machine will be $10 million per year. The required return is 8 %, and the tax rate is 38%. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Answer 1

To determine the better investment, we compare the net present values (NPVs) of the two machines. Machine B has a higher NPV, making it the better investment.

Step-by-step explanation:

In order to determine which machine is the better investment, we need to compare their net present values (NPVs) using the required return rate of 8%. Net present value is calculated by subtracting the initial cost of the machine from the present value of the cash flows it generates over its useful life.

For Machine A, the initial cost is $3.1 million and the cash flows are $10 million per year for 6 years. Using the formula for present value, we find that the present value of the cash flows is approximately $47.19 million. Subtracting the initial cost, the NPV for Machine A is about $44.09 million.

For Machine B, the initial cost is $5.1 million and the cash flows are $10 million per year for 9 years. Using the same formula, the present value of the cash flows is approximately $67.34 million. Subtracting the initial cost, the NPV for Machine B is about $62.24 million.

Since the NPV for Machine B is higher than the NPV for Machine A, Machine B is the better investment choice.