Marvel Company is considering the acquisition of two machines. Machine A Machine

Question

Marvel Company is considering the acquisition of two machines.

                        Machine A Machine B

Initial investment $200,000 $200,000

Annual operating revenues (end of year) $100,000 $160,000

Annual expenses (end of year) $25,000 $85,000

Terminal salvage value $10,000 $20,000

Estimated useful life 5 years 5 years

Minimum desired rate of return 14% 14%

Assume straight-line depreciation. Ignore income taxes. The present value of an ordinary annuity of one at 14% and 5 periods is 3.4331. The present value of one at 14% and 5 periods is 0.5194.

1) Assume there are enough funds to purchase both machines. Should both machines be purchased?

2) Assume there are funds to purchase only one machine. Which machine should be purchased?

Explanation / Answer

NPV of Machine 1 = $200,000 - ($75,000*3.4331)+($10,000*0.5194)

=$62,676

NPV of Machine 2 = $200,000 - ($75,000*3.4331)+($20,000*0.5194)

= $67,870

1) Yes , both Machines should be purchased.

2) Assuming there are funds to purchase only one machine then Machine 2 should be purchased.

Note: Depreciation is ignored since it is a non cash expenditure.

Initial CF 200000 200000 Income 100000 160000 Expenses 25000 85000 Net CF 75000 75000

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