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ID: 2530890 • Letter: H
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home / study / business / finance / finance questions and answers / . barnes company purchases a machine for $500,000. the machine has an expected life of 10 years ...
Justin Manufacturing is considering purchasing two machines. Each machine costs $9,000 and will produce cash flows as follows:
End of Machine A Machine B
Year
1 $5,000 $1,000
2 $4,000 $2,000
3 $3,000 $12,000
Justin Manufacturing uses the net present value method to make the decision, and it requires a 15% annual return on its investments. The present value factors of 1 at 15% are: 1 year, 0.8696; 2 years, 0.7561; 3 years, 0.6575. Which machine should Justin purchase and why? Hint: This is a two-part question. Part 1. Make sure you calculate the NPV for both machines and Part 2. Which machine should the company invest in and why?
Explanation / Answer
Part 1.
MACHINE A
Net Present Value = Present Value of Cash flows – Initial Investment
= [($5000 x 0.8696) + ( $4000 x 0.7661) + ($3000 x 0.6575) ] - $9000
= $4348 + $3024.40 + $1972.5 - $9000
= $344.5
Net Present Value - MACHINE A = $344.5
MACHINE B
Net Present Value = Present Value of Cash flows – Initial Investment
= [($1000 x 0.8696) + ( $2000 x 0.7661) + ($12000 x 0.6575) ] - $9000
= $869.6 + $1512.2 + $7890 - $9000
= $1271.8
Net Present Value - MACHINE A = $1271.8
Part 2. Which machine should the company invest in and why ?
Justin should make investment in Machine B, Since it has a higher NPV of $1271.8
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