MKM International is seeking to purchase a new CNC machine in order to reduce co

Question

MKM International is seeking to purchase a new CNC machine in order to reduce costs. Two alternative machines are in consideration. Machine 1 costs $ 500,0000 but yields a 15 percent savings over the current machine used. Machine 2 costs $ 800,000 but yields a 25 percent savings over the current machine used. In order to meet demand, the following forecasted cost information for the current machine is also provided.

1,000,000

a) Based on the NPV of cash flows for these 5 years, which macine should MKM International purchase? Assume a discount rate of 13 percent?

NPV of machine 1 $ _____?

NPV of machine 2 $______?

b) Based on the NPV......8 percent?

NPV of machine 1?

NPV of machine 2?

YEAR Project Cost 1

1,000,000

2 1,250,000 3 1,400,000 4 1,550,000 5 2,400,000

Explanation / Answer

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As the table was cut in the above, showing the last 4 columns again:

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Present Value = PV

PV Factor = 1 / ( ( 1+ rate) ^ n)

where n = number of years or time periods

rate = rate of return or discount rate

Future Value = FV = PV * (1+rate)^n

Hence PV = FV / ( (1+rate)^n)

After referring to the table, we get:

a) Based on 13%

NPV of machine1: $263,114.08

NPV of machine2: $382,249.08

b) Based on 8%

NPV of machine1: $471,856.80

NPV of machine2: $670,415.13

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Year Present Cost                 Cost Money Saved Profit Volume Factor PV Saved 1st Machine CM1 2nd Machine CM2 1st machine 2nd machine at 13% at 8% 1st Machine 2nd Machine at 13% at 8% at 13% at 8% Short notation pc 15% savings 25% savings SM1 SM2 pv1 pv2 SM1*pv1 SM1*pv2 SM2*pv1 SM2*pv2 pc-pc*0.15 pc-pc*0.25 pc-CM1 pc-CM2 1 / ( ( 1+ rate) ^ n) 1 $1,000,000.00 1,000000-1000000*0.15= $850,000.00 $750,000.00 $150,000.00 $250,000.00 1/(1+0.13)= 0.88495575 0.925926 $132,743.36 $138,888.89 $221,238.94 $231,481.48 2 $1,250,000.00 1250000-1250000*0.15= $1,062,500.00 $937,500.00 $187,500.00 $312,500.00 1/(1+0.13)^2= 0.78314668 0.857339 $146,840.00 $160,751.03 $244,733.34 $267,918.38 3 $1,400,000.00 $1,190,000.00 $1,050,000.00 $210,000.00 $350,000.00 0.69305016 0.793832 $145,540.53 $166,704.77 $242,567.56 $277,841.28 4 $1,550,000.00 $1,317,500.00 $1,162,500.00 $232,500.00 $387,500.00 1/(1+0.13)^4= 0.61331873 0.73503 $142,596.60 $170,894.44 $237,661.01 $284,824.07 5 $2,400,000.00 2400000-2400000*0.15= $2,040,000.00 $1,800,000.00 $360,000.00 $600,000.00 1/(1+0.13)^5= 0.54275994 0.680583 $195,393.58 $245,009.95 $325,655.96 $408,349.92 Sum of all the 5 years total = $763,114.08 $882,249.08 $1,271,856.80 $1,470,415.13 Less: Initial cost of each machine $500,000.00 $500,000.00 $800,000.00 $800,000.00 Net Present Value $263,114.08 $382,249.08 $471,856.80 $670,415.13

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