1. Consider the following two mutually exclusive investment alternatives: Net Ca
ID: 1180168 • Letter: 1
Question
1. Consider the following two mutually exclusive investment alternatives:
Net Cash Flow
End of Year
Option A
Option B
0
-$4000
-$2000
1
-$500
-$600
2
-$600
-300
3
-$800
-$700 + $200
4
-$400 + $250
Suppose that your company needs either machine for only 3 years. The net proceeds from the sale of machine B are estimated to be $200. What should be the required net proceeds from the sale of machine A so that both machines could be considered economically indifferent at an interest rate of 10%?
Net Cash Flow
End of Year
Option A
Option B
0
-$4000
-$2000
1
-$500
-$600
2
-$600
-300
3
-$800
-$700 + $200
4
-$400 + $250
Explanation / Answer
PV of cash flow for Option B = -2000-(600/1.1)-(300/1.1^2)-(500/1.1^3) = -$3169.04
For Option A to be indifferent from B
PV of Cash flow for option A= Option B
-3169.04 = -4000-(500/1.1)-(600/1.1^2)-((800-x)/1.1^3)
4950.41-3169.04= -((800-x)/1.1^3)
1781.37*1.1^3 =
2371.00 = -800+x
required net proceeds from the sale of machine A, x = 2371+800 = $3171
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