Jim D\'Addario of the well-known guitar and bass string factory D\'Addario Strin

Question

Jim D'Addario of the well-known guitar and bass string factory D'Addario Strings in Long Island, NY, is considering two new designs for more efficient and higher quality machines (the company has won many manufacturing and product patents in the field).

Assume machine A costs $750,000 to make and is expected to return the following net earnings over five years, after which time it is retired: $10 million, $9 million, $8 million, $7 million, and $6 million, respectively.

Assume machine B costs $850,000 to make and is expected to return the following net earnings over five years, after which time it is also retired: $10.1 million, $9.1 million, $8.1 million, $7.1 million, and $6.1 million, respectively.

All other things being equal, which design should Jim go with if he is using a discount rate of 7%?

Hint: Use NPV analysis.

Explanation / Answer

The machine which has higher NPV should be selected.

Calculation of NPV of both machines:

So Machine B design should be selected since it has higher NPV.

YEAR Machine A Cashflow $ PVF@7% Present Value $ 0                        (750,000.00) 1                   (750,000.00) 1                    10,000,000.00 0.934579439                  9,345,794.39 2                      9,000,000.00 0.873438728                  7,860,948.55 3                      8,000,000.00 0.816297877                  6,530,383.02 4                      7,000,000.00 0.762895212                  5,340,266.48 5                      6,000,000.00 0.712986179                  4,277,917.08 NPV + 32,605,309.52

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