The Perez Company has the opportunity to invest in one of two mutually exclusive

Question

The Perez Company has the opportunity to invest in one of two mutually exclusive machines that will produce a product it will need for the foreseeable future Machine A costs $10,000,000 but realizes after-tax inflows of $3,250,000 per year for 4 years. After 4 years, the machine must be replaced. Machine B costs $15,000,000 and realizes after-tax inflows of $3,500,000 per year for 8 years, after which it must be replaced. Assume that machine prices are not expected to rise because inflation will be offset by cheaper components used in the machines. The cost of capital is 8.00%

1 What is the NPV of Project A?

2 What is the NPV of Project B?

3 Which project is the better project and why?

4 What is the Equivalent Annual Annuity for Project A?

5 What is the Equivalent Annual Annuity for Project B?

Explanation / Answer

1. NPV of Project A = -$10,000,000 +$3,250,000/1.08 + $3,250,000/1.08^2 + $3,250,000/1.08^3 + $3,250,000/1.08^4 = $764,412.23 2. NPV of Project B =-$15,000,000 +$3,500,000/1.08 + $3,500,000/1.08^2 .....$3,500,000/1.08^8 =$5,113,236.30 3. Project B is better because it has higher NPV

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