When do I use the Present value of 1 table or the present value of an annuity ta

Question

When do I use the Present value of 1 table or the present value of an annuity table? I thought since cash in flow are equal yearly, I only use one factor of the present value. Is there a rule of thumb? Also, why is the 5th year changed from 53,000 to 68,000? Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 10% rate of return on its investments. (PV0fS1. EyofS1. PVAof$1, and EAof$1) (Use appropriate factor(s) from the tables provided.) Alternative 1: Keep the old machine and have it overhauled. If the old machine is overhauled, it will be kept for another five years and then sold for its salvage value. Cost of old machine Cost of overhaul Annual expected revenues generated Annual cash operating costs after overhau Salvage value of old machine in 5 years $112,000 150,000 95,000 42,000 15,000 Alternative 2: Sell the old machine and buy a new one. The new machine is more efficient and will yield substantial operating cost savings with more product being produced and sold. Cost of new machine Salvage value of old machine now Annual expected revenues generated Annual cash operating costs Salvage value of new machine in 5 years $ 300,000 29,000 100,000 32,000 20,000 Required:

Explanation / Answer

When the cashflows are are equal yearly, one can use present value of annuity factor. In case of unequal cashflows, it is mandatory to use present value of 1 table. In the alternative 1 situation, the cashflows are not equal for all the 5 years. Although the operating cashflows are equal for years 1 to 5, however in year 5, there is an additional cashflow amounting to $15,000. This additional cashflow is on account of salvage value of machine. Hence, the total cashflow of year 5 is $68,000 ($53,000 + $15,000)

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