Question

Sunland Corp. is considering purchasing one of two new processing machines. Either machine would make it possible for the company to produce its products more efficiently than it is currently equipped to do. Estimates regarding each machine are provided below. Machine A Machine B Original cost $113,200 $269,600 Estimated life 10 years 10 years Salvage value Estimated annual cash inflows $29,800 $60,300 Estimated annual cash outflows $7,600 $15.000 Calculate the net present value and profitability index of each machine. Assume an 8% discount rate. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 2 decimal places es. 589.71. Enter negative amounts using either a negative sign preceding the number c.g. -45.35 or parentheses e.. (45.35)) Machine A Machine B Net present value S Profitability Index Which machine should be purchased? Sunland Corp. should purchase eTextbook and Media

Answer 1

Ans.:

Machine -A: Annual Cash Flow = $29,800 -$7,600 = $22,200

Rate of Return	8.00%
Year	Amount (₹)	Discounting Factor @ 8%	Present Value
1	$      22,200.00	0.92593	$     20,555.56
2	$      22,200.00	0.85734	$     19,032.92
3	$      22,200.00	0.79383	$     17,623.08
4	$      22,200.00	0.73503	$     16,317.66
5	$      22,200.00	0.68058	$     15,108.95
6	$      22,200.00	0.63017	$     13,989.77
7	$      22,200.00	0.58349	$     12,953.49
8	$      22,200.00	0.54027	$     11,993.97
9	$      22,200.00	0.50025	$     11,105.53
10	$      22,200.00	0.46319	$     10,282.90
			$     148,963.81

Hence,

NPV = Present Value of Cash Flows - Initial Investment

= $148,963.81 - $113,200

= $ 35,763.81

Profitability Index = Present value of Future Cash Flows / Initial Investment

= $148,963.81 / $113,200

= 1.32

Machine -B: Annual Cash Flow = $60,300 -$15,000 = $45,300

Rate of Return	8.00%
Year	Amount (₹)	Discounting Factor @ 8%	Present Value
1	$      45,300.00	0.92593	$     41,944.44
2	$      45,300.00	0.85734	$     38,837.45
3	$      45,300.00	0.79383	$     35,960.60
4	$      45,300.00	0.73503	$     33,296.85
5	$      45,300.00	0.68058	$     30,830.42
6	$      45,300.00	0.63017	$     28,546.68
7	$      45,300.00	0.58349	$     26,432.11
8	$      45,300.00	0.54027	$     24,474.18
9	$      45,300.00	0.50025	$     22,661.28
10	$      45,300.00	0.46319	$     20,982.67
			$ 3,03,966.69

Hence,

NPV = $303,966.69 - $269,600

= $34,366.69

Profitability Index = $303,966.69 / $269,600

= 1.13

Therefore,

Sunland Corp. should purchase Machine A as it has greater NPV and Profitability Index as compared to Machine B.

Machine -C: Annual Cash Flow = $44,700 -$10,000 = $34,700 ; Residual Value = $29,700

Rate of Return	8.00%
Year	Amount (₹)	Discounting Factor @ 8%	Present Value
1	$      34,700.00	0.92593	$     32,129.63
2	$      34,700.00	0.85734	$     29,749.66
3	$      34,700.00	0.79383	$     27,545.98
4	$      34,700.00	0.73503	$     25,505.54
5	$      34,700.00	0.68058	$     23,616.24
6	$      34,700.00	0.63017	$     21,866.89
7	$      34,700.00	0.58349	$     20,247.12
8	$      34,700.00	0.54027	$     18,747.33
9	$      34,700.00	0.50025	$     17,358.64
10	$      64,400.00	0.46319	$     29,829.66
			$ 2,46,596.67

Hence,

NPV = $246,596.67 - $250,400

= ($3,803.33)

Profitability Index = $246,596.67 / $250,400

= 0.98

Now,

Ranking The Investments = (Rank 1 represents the best)

Particulars	NPV	Profitability Index(PI)	Rank (Based on NPV)	Rank (Based on PI)
Machine A	$ 35,763.81	1.32	1	1
Machine B	$34,366.69	1.13	2	2
Machine C	($3,803.33)	0.98	3	3

Hence,

Machine A should be chosen based on calculation of NPV as well as Profitability Index

Conclusion = Machine A should be purchased as it provides the highest NPV and has the best profitability index.

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