The Perez Company has the opportunity to invest in one of the mutually exclusive

Question

The Perez Company has the opportunity to invest in one of the mutually exclusive machines that will produce a product it will need the foreseeable future. Machine A costs $10 million but realizes after-tax inflows of $4 million per year for 4 years. After 4 years, the machine must be replaced. Machine B costs $15 million and realizes after-tax inflows of $3.5 million |per year for 8 years, after which it must lie replaced, Assume that machine prices are not expected to rise because inflation will be offset by cheaper components used in the machines. The cost of capital is 10%. By how much would the value of the company increase if it accepted the better machine? What is die equivalent annual annuity for each machine?

Explanation / Answer

First step is to calculate the present value of the two opportunities.

Machine A:

Sum = 2679461.79

Machine B:

Sum = 3672241.7

Value of the company increases by choosing better machine A = 3672241.7-2679461.79 = 992779.91

Equivalent Annual Annuity:

Machine A:

= 845291.96$

Machine B:

= 688339.74$

Year Cashflow 10% Discount
Factor Present Value 0 -10000000 1 -10000000 1 4000000 0.9091 3636363.636 2 4000000 0.8264 3305785.124 3 4000000 0.7513 3005259.204 4 4000000 0.6830 2732053.821

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