Question

Blue Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn’t equipped to do. Estimates regarding each machine are provided below.

		Machine A		Machine B
Original cost		$76,900		$186,000
Estimated life		8 years		8 years
Salvage value		0		0
Estimated annual cash inflows		$19,600		$39,800
Estimated annual cash outflows		$5,150		$10,080

Click here to view PV table.

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. (If the net present value is negative, use either a negative sign preceding the number e.g. -45 or parentheses e.g. (45). Round answers for present value to 0 decimal places, e.g. 125 and profitability index to 2 decimal places, e.g. 10.50. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

		Machine A		Machine B
Net present value
Profitability index

Which machine should be purchased?

Machine AMachine B should be purchased.

Answer 1

Machine - A.

>> Net Present Value = Present Value of future Net cash inflows - Initial investment.

>> Net Cash Flows annual = $ 19,600 - $ 5,150

>> Net Cash Flows annual = $ 14,450.

>> Present Value of future Net cash inflows = [ $ 14,450 * PVIFA ( 9 % , 8 Years ) ]

>> Present Value of future Net cash inflows = [ $ 14,450 * 5.535 ]

>> Present Value of future Net cash inflows = $ 79,980.

>> Net Present Value = $ 79,980 - $ 76,900

>> Net Present Value = $ 3080.

>> Profitable index = Present value future cash flows / Initial investment.

>> Profitable index = $ 79,980 / $ 76,900 = 1.04

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Machine - B.

>> Net Present Value = Present Value of future Net cash inflows - Initial investment.

>> Net Cash Flows annual = $ 39,800 - $ 10,080

>> Net Cash Flows annual = $ 29,720.

>> Present Value of future Net cash inflows = [ $ 29,720 * PVIFA ( 9 % , 8 Years ) ]

>> Present Value of future Net cash inflows = [ $ 29,720 * 5.535 ]

>> Present Value of future Net cash inflows = $164,500.

>> Net Present Value = $164,500 - $ 186,000

>> Net Present Value = $ ( 21,500 ).

>> Profitable index = Present value future cash flows / Initial investment.

>> Profitable index = $ 164,500 / $ 186,000 = 0.88.

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>> Machine - A is selected because machine -A, Net Present Value is positive and Profitable index is higher than Machine - B