Athena, Inc. is analyzing two machines to determine which one it should purchase

Question

Athena, Inc. is analyzing two machines to determine which one it should purchase. The company requires a 14% rate of return and uses straight-line depreciation to a zero book value. Machine A has a cost of $290,000, annual operating costs of $8,000, and a 3-year life. Machine B costs $180,000, has annual operating costs of $12,000, and has a 2-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should Bruno's purchase and why? (Round your answer to whole dollars.). Explain and please show work. Machine B; because it will save the company about $11,600 a year Machine B; because its equivalent annual cost is $199,759 Machine A; because it will save the company about $132,912 a year Machine B; because it will save the company about $200,000 a year Machine A; because it will save the company about $8,600 a year

Explanation / Answer

3. Bruno's, Inc. is analyzing two machines to determine which one it should purchase. The company requires a 14% rate of return and uses straight-line depreciation to a zero book value. Machine A has a cost of $290,000, annual operating costs of $8,000, and a 3-year life. Machine B costs $180,000, has annual operating costs of $12,000, and has a 2-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should Bruno's purchase and why? (Round your answer to whole dollars.) Machine A: Year Investment Operating costs Total cashflow PV @14% 0 290,000 290,000 $290,000.00 1 8,000 8,000 $7,017.54 2 8,000 8,000 $6,155.74 3 8,000 8,000 $5,399.77 Total present value of cash flows = $308,573.06 $132,891.07 Equivalent annual cost = Net present value of the project/ PV of annuity corresponding to life of the project at given cost of capital PV of annuity for 3 years @14% = 2.322 (present value of an annuity table values @14% for 3 years) PV of annuity for 2 years @14% = 1.647 (present value of an annuity table values @14% for 2 years) EAC = 308,573.06/ 2.322 = $132,891.07 Machine B: Year Investment Operating costs Total cashflow 0 180,000 180,000 $180,000.00 1 12,000 12,000 $10,526.32 2 12,000 12,000 $9,233.61 Total present value of cash flows = $199,759.93 Equivalent annual cost = Net present value of the project/ PV of annuity corresponding to life of the project at given cost of capital EAC = 199,759.93/ 1.647 = $121,287.14 Bruno should buy machine B as it saves costs of $11,603.92 (132,891.07 - 121,287.14) per annum. 4. A stock has had the following year-end prices and dividends. Calculate the arithmetic and geometric returns for the stock. year Price Dividend Annual return 1 40.00 0 0 2 46.50 0.25 (46.50 - 40.00 + 0.25)/40 = 16.88% 3 44.00 0.45 (44.00-46.50+0.45)/46.50 = -4.41% 4 54.80 0.55 (54.80-44.00+0.55)/44.00= 25.80% 5 62.25 0.75 (62.25-54.80+0.75)/54.80= 14.96% Arithmetic return of stock = 16.88% - 4.41% + 25.80% + 14.96% 4 = 13.31% Geometric return of stock = [(1 + 16.88%) x (1 -4.41%) x (1 + 25.80%) x (1 + 14.96%)]^1/4 - 1 Year return 1 + return 1 0.1688 1.1688 2 -0.0441 0.9559 3 0.2580 1.2580 4 0.1496 1.1496 GM = 0.1274 or 12.74% 5. Determine the expected portfolio return based on the following information:

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