Exercise 26-4 BAK Corp. is considering purchasing one of two new diagnostic mach
ID: 2585235 • Letter: E
Question
Exercise 26-4 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 Machine A $77,000 8 years Machine B $188,000 8 years Original cost Estimated life Salvage value Estimated annual cash inflows Estimated annual cash outflows $19,900 $4,800 $40,200 $9,860 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. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Machine A Machine B Net present value Profitability index Which machine should be purchased? 1should be purchasedExplanation / Answer
Machine A
Present value of net annual cash flows ($19,900 - $4,800) x 5.53482 = $83,576 present value
Add: Present value of salvage value $0 x 0.50187 = 0
Less: Capital investment = $77,000
Net present value = $6,576
Profitability index = Present Value of cash inflow / Present Value of cash inflow
= $83,576 / $77,000 = 1.09
Machine B
Present value of net annual cash flows ($40,200 - $9,860) x 5.53482 = $167,926 present value
Add : Present value of salvage value $0 x 0.50187 = 0
Less: Capital investment = $188,000
Net present value = $(20,074)
Profitability index = Present Value of cash inflow / Present Value of cash inflow
= $167,926 / $188,000 = 0.89
Machine B should be rejected and Machine A should be purchased, because the Machine B has a negative net present value and a lower profitability index.
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