You are considering the purchase of one of two machines used in your manufacturi

Question

You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $1000 initially, and then $300 per year in maintenance costs. Machine B costs $1300 initially, has a life of three years, and requires $200 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 8% and the tax rate is zero.

Capital Budgeting Exercise 2

Your company has spent $400,000 on research to develop a new computer game. The firm is planning to spend $600,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine will be used for 3 years, has a $100,000 estimated resale value at the end of three years, and will be depreciated straight line over 4 years. Revenue from the new game is expected to be $800,000 per year, with costs of $300,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 8 percent, and it expects net working capital to increase by $150,000 at the beginning of the project. Should you proceed with this project? Explain.

Should you proceed with this project? Explain.

Explanation / Answer

year ...................0......................1.....................2......................3................4

machine A......1000.................300.................300

machine B......1300................200.................200................200

macine A EAC -= 860.57

machine B EAC = 704.19

we choose machine B as its equal annual cost is minimum

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