Question

The new machine will increase cash flow by $326,000 per year. You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will be obsolete 10 years from today. The machine is currently priced at $1,760,000. The cost of the machine will decline by $111,000 per year until it reaches $1,205,000, where it will remain.

1. If your required return is 13 percent, calculate the NPV today.
2. If your required return is 13 percent, calculate the NPV for the following years.
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
3. Should you purchase the machine?
4. If so, when should you purchase it?
A. Today
B. One year from now
C. Two years from now

Answer 1

1. If your required return is 13 percent, calculate the NPV today.

initial outlay -$1,760,000

10 annual cash flows $326,000

NPV = $8,955.37

2. If your required return is 13 percent, calculate the NPV for the following years.

Year 1

initial outlay -$1,649,000

9 annual cash flows $326,000

NPV = $23,919.57

Year 2

initial outlay -$1,538,000

8 annual cash flows $326,000

NPV = $26,399.12

Year 3

initial outlay -$1,427,000

7 annual cash flows $326,000

NPV = $14,771

Year 4

initial outlay -$1,316,000

6 annual cash flows $326,000

NPV = -$12,798.77

Year 5

initial outlay -$1,205,000

5 annual cash flows $326,000

NPV = -$169,382.61

Year 6

initial outlay -$1,205,000

4 annual cash flows $326,000

NPV = -$346,322.35

3. Should you purchase the machine?

You can purchase the machine this year, but it would be more profitable if you purchase it later.

4. If so, when should you purchase it?

C. Two years from now