Question

Precision Plumbus is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straight-line depreciation to a zero book value over the life of its equipment. Machine A has a cost of $905,000, annual operating costs of $27,000, and a 4-year life. Machine B costs $1,025,000, has annual operating costs of $20,000, and has a 5-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should be purchased?

Answer 1

Period	Machine A	Machine B	PV@15%	PV of amount for A	PV of amount for B
0	905000	1025000	1	905000	1025000
1	27000	20000	.8696	23479	17392
2	27000	20000	.7561	20415	15122
3	27000	20000	.6575	17753	13150
4	27000	20000	.5718	15439	11436
5		20000	.4972		9944

the above table shows the PV of Cash outflows

Total Cash outflow of Machine A = 982086

Total Cash outflow of Machine B = 1092044

since machines are of unequal life we use equivalent annual annuity approach

Annual Net present Value = Net present Value/ Annuity discount Factor for the Project life

Annuity factor for machine A = 2.8850

Annuity factor for Machine B = 3.3522

Annual Net present value for A = 982086/2.8550= 343988

Annual Net present value for B = 1092044/3.3522= 325769

since we are considering only outflow and we see that Annual outflow value of A (343988)> Annual outflow of B(325769)

Hence we should choose Machine B.