BAK Corp. is considering purchasing one of two new diagnostic machines. Either m

Question

BAK Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn’t equipped to do. Estimates regarding each machine are provided below.

Click here to view the factor table.

(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer for present value to 0 decimal places, e.g. 125 and profitability index to 2 decimal places, e.g. 10.50.)

Which machine should be purchased?

Machine A Machine B Original cost $78,230 $187,700 Estimated life 8 years 8 years Salvage value 0 0 Estimated annual cash inflows $20,220 $39,760 Estimated annual cash outflows $4,860 $9,930

Explanation / Answer

Machine A:

Initial Investment = $78,230

Annual Net Cash Flows = Annual Cash Inflows - Annual Cash Outflows
Annual Net Cash Flows = $20,220 - $4,860
Annual Net Cash Flows = $15,360

Present Value of Annual Net Cash Flows = $15,360 * PVA of $1 (9%, 8)
Present Value of Annual Net Cash Flows = $15,360 * 5.5348
Present Value of Annual Net Cash Flows = $85,014.53

Net Present Value = Present Value of Annual Net Cash Flows - Initial Investment
Net Present Value = $85,014.53 - $78,230
Net Present Value = $6,784.53

Profitability Index = Present Value of Annual Net Cash Flows / Initial Investment
Profitability Index = $85,014.53 / $78,230
Profitability Index = 1.09

Machine B:

Initial Investment = $187,700

Annual Net Cash Flows = Annual Cash Inflows - Annual Cash Outflows
Annual Net Cash Flows = $39,760 - $9,930
Annual Net Cash Flows = $29,830

Present Value of Annual Net Cash Flows = $29,830 * PVA of $1 (9%, 8)
Present Value of Annual Net Cash Flows = $29,830 * 5.5348
Present Value of Annual Net Cash Flows = $165,103.08

Net Present Value = Present Value of Annual Net Cash Flows - Initial Investment
Net Present Value = $165,103.08 - $187,700
Net Present Value = -$22,596.92

Profitability Index = Present Value of Annual Net Cash Flows / Initial Investment
Profitability Index = $165,103.08 / $187,700
Profitability Index = 0.88

Based on above calculations, company should purchase Machine A.

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