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.

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate.

Profitability index

Which machine should be purchased?

Machine A Machine B Original cost $74,000 $179,000 Estimated life 8 years 8 years Salvage value 0 0 Estimated annual cash inflows $19,500 $39,500 Estimated annual cash outflows $4,800 $9,800

Explanation / Answer

Net present value = Present value of cash inflows - Present value of cash outflows

Profitability index = Present value of cash inflows / Present value of cash outflows

Which machine should be purchased - Machine A (positive NPV and higher Profitability index)

Machine A Machine B Estimated annual net cash inflows 14,700 (19,500-4,800) 29,700 (39,500-9,800) PVAF of 9% for 8 years 5.535 5.535 Present value of cash inflows 81,364.5 164,389.5 Present value of cash outflows 74,000 179,000

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