Machine A costs $15,000 and will last 5 years, at which time the value of the ma

ID: 2729850 • Letter: M

Question

Machine A costs $15,000 and will last 5 years, at which time the value of the machine is $5,000 (it is worth $7,000 in 4 years). Machine B costs $12,000 and will last 3 years, after which the machine is worth $4,000. You can lease a Machine B (only if you purchased one initially) for $3,000 per year (payment due at end of year). You need a machine for 4 years, and either machine can be repurchased in the future for the same price. If both machines have the same production speed and capacity, which machine should you purchase (Interest=10% annually, show your work).

Explanation / Answer

Net Present Value of Machine A:

Year

Cash Flow

PVF (10%)

PV of Cash Flow

-$15000

$4000

0.7513

$3005.2

-$11994.8

Machine B:

Since we need a machine B for 4 years and the life of machine B is only 3 years, it would be better to lease the machine B.

NPV of leasing Machine B

= -$3000 * PVAF (10%, 4 years)

= -$3000 * 3.1699

= -$9509.7

Since both the machines have same production speed and capacity, the machine with higher NPV should be purchased.

Since machine B has the higher NPV, Machine B should be considered and to be leased.