Each is expected to last for 10 years, with no salvage value. Machine A costs $5

Question

Each is expected to last for 10 years, with no salvage value. Machine A costs $5000 and has a Uniform Annual Benefit of $600 per year. Machine B costs $7000 and has a Uniform Annual Benefit of $700 per year. You would need to take out a loan at 6% to buy either machine. a) How many alternatives do you have? b) What should you do? Do an NPV analysis. c) Now do an EUAW analysis of the above. Is the conclusion the same? You discover that your company has $10,000 available in a savings account earning 3% interest, and your boss says this money can be withdrawn to pay for either machine. d) Now, what should you do? Do an NPV analysis. e) To the nearest half-percent, what rate-of-return would you be earning on Machine A?

Explanation / Answer

a).Either we will buy A, either we will buy B or we will not buy any of these

b).

first we have to calculate NPV of each machine

NPV machine A = -5000+600*PVIFA(6,10) = -5000+600*7.3101 = -$613.94

NPV of machine B = -7000+700*PVIFA(6,10) = -7000+700*7.3101 = -$1822.93

since both have -ve NPV, we should not buy any of these or if they are mutually exclusive then machine A is better option

c). Using EUAW analysis, first we have to calculate PV of all the cash flow which is equal to NPV

for machine A

PV = -5000+600*PVIFA(6,10) = -$613.94

Now this PV is equal to uniform annual cashflow, A

A*PVIFA(6,10) = -613.94

A = -613.94/7.3101 = -$83.98

similarly for machine B

PV = -7000+700*PVIFA(6,10) = -$1882.93

A*PVIFA(6,10) = -1882.93

A = -1882.93/7.3101 = -$257.60

Both have -ve equavalent worth so we wil not choose any of these however we are compelled to chose then we can chose Machine A as it has less -ve NPV and less -ve annual worth

yes the conclusion is the same

d).

again doing an NPV analysis for interest rate 3%

NPV for amchine A = -5000+600*PVIFA(3%,10) = -5000+600*8.5302 = $118.12

NPV for amchine B = -7000+700*PVIFA(3%,10) = -7000+700*8.5302 = -$1028.86

Project A should be chosen at interest rate of 3%

e).

earning on machine A is,

we have to calulate IRR

NPV = 0 =-5000+600*PVIFA(IRR,10)

5000/600 = PVIFA(IRR,10)

by hit and trial method

IRR = 3.46%

we are earning a return of 3.46% on machine A

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