Your Company is deciding whether to invest in a new machine. the new machine wil

Question

Your Company is deciding whether to invest in a new machine. the new machine will increase cash flow by $375,000 per year. You believe the technology used in the machine has a 10-year life;in other words, no matter when you purchase the machine, it will be obsolete 10 years from today. The machine is currently priced at $2,100,000. The cost of the machine will decline by $150,000 per year until it reaches $1,350,000, where it will remain. If your required return is 12 percent, should you purchase the machine? If so, when should you purchase it?

Explanation / Answer

Decision: As the NPV of machine is positive $453497.19, Company should go for purchase of machine.

Note: It is assumed that the machine will be scrapped at the end of 10th year at its terminal book value of $1350000

Calculation of Net Present Value if Machine is Purchased Year Cash Outflows/Inflows Present Value Factor@12% Present Value of Cash flows 0 -2100000 1.000 -2100000 1 375000 0.893 334821.43 2 375000 0.797 298947.70 3 375000 0.712 266917.59 4 375000 0.636 238319.28 5 375000 0.567 212785.07 6 375000 0.507 189986.67 7 375000 0.452 169630.96 8 375000 0.404 151456.21 9 375000 0.361 135228.76 10 375000 0.322 120739.96 10 1350000 0.322 434663.55 Net Present Value(NPV) 453497.19

Decision: As the NPV of machine is positive $453497.19, Company should go for purchase of machine.

Note: It is assumed that the machine will be scrapped at the end of 10th year at its terminal book value of $1350000

Note 2: Value of present value factor@12 % to be taken from annuity table.

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