Homework Answers
Present value of annuity at 10% for 8 years is 5.33493
Net cash flows = Estimated cash inflows - Estimated cash outflows
Machine A = $22,000 - $5,150 = $16,850
Machine B = $40,200 - $8,850 = $31,350
Present value of cash inflows = Net cash flows X Present value of annuity
Machine A = $16,850 X 5.33493 = $89,894
Machine B = $31,350 X 5.33493 = $167,250
Net present value = Present value of cash inflows - Original cost
Machine A = $89,894 - $78,200 = $11,694
Machine B = $167,250 - $189,600 = -$22,350
Profitability index = Present value of cash inflows / Original cost
Machine A = $89,894 / $78,200 = 1.150
Machine B = $167,250 / $189,600 = 0.882
| Machine A | Machine B | |
| Net present value | $11,694 | -$22,350 |
| Profitability index | 1.150 | 0.882 |
Machine A should be purchased because it has positive Net present value and higher Profitability index.
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