1. Machines A and B are Mutually exclusive and are expected to produce the follo
ID: 2707225 • Letter: 1
Question
1. Machines A and B are Mutually exclusive and are expected to produce the following real cash flows:
Machine
Co
C1
C2
C3
C4
C5
A
-400
200
400
300
B
-600
100
300
200
200
100
The real opportunity cost of capital is 10%.
a. Calculate the NPV of each Machine. (4 points)
b. Calculate the equivalent annual cash flow from each Machine (8 points)
Which machine would you buy? (3 points)
Machine
Co
C1
C2
C3
C4
C5
A
-400
200
400
300
B
-600
100
300
200
200
100
Explanation / Answer
a. NPV of A = -400+200/1.1^1+400/1.1^2+300/1.1^3 = 337.79
NPV of B = -600+100/1.1^1+300/1.1^2+200/1.1^3+200/1.1^4+100/1.1^5 = 87.80
b. Let EACF of A be X. Then 337.79=X*(1-1/1.1^3)/10%=X*2.487
Solving, we get X=EACF of A = 135.83
Let EACF of B be Y. Then 87.80=Y*(1-1/1.1^5)/10%=X*3.79
Solving, we get Y=EACF of B = 23.16
We should buy Machine A as its NPV and EACF are higher than those of Machine B.
Hope this helped ! Let me know in case of any queries.
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