Question

Corporate Finance

5. (20 points) Office Automation, Inc., is obliged to choose between two copiers, XX40 or RH45 Xx40 costs less than RH45, but its economic life is shorter. The costs and maintenance expenses of these two copiers are given as follows. These cash flows are expressed in real terms. Copier XX40 RH45 Year0 2 3 4 5 $700 S100 $100 $100 900 10 10 10 110 110 The inflation rate is 5% and the nominal discount rate is 14%. Assume that revenues are the same regardless of the copier, and that whichever copier the company chooses, it will buy the model forever. Which copier should the company choose? Ignore taxes and depreciation.

Answer 1

Assumptions 1: No taxes or depreciation

Assumption 2: Revenues are same for the copiers

Given these assumptions, we'll base our answer on the present value of the costs and maintenance expenses of the two copiers.

Present value, PV = Cash flow / (1+rate of return)^number of periods

Here the rate of return will be nominal rate minus the inflation rate that is 14%-5%= 9%

Total expense for copier XX40 = $700+ PV1 + PV2 + PV3 for the 3 years.

=$700+ [$100/(1+0.09)^1] + [$100/(1+0.09)^2] + [$100/(1+0.9)^3]

Total expense for copier XX40 = $700 + $91.74 + $84.17 + $77.22 = $953.13

Similarly we'll calculate the total expense for copier RH45 = $900 + [$110/(1.09)^1] + [$110/(1.09)^2] + [$110/(1.09)^3] + [$110/(1.09)^4] + {$110/(1.09)^5] = $1327.86

The overall costs for XX40 is less than RH45. However if we look at the maintenance costs for the last two years and also the economic life of the copiers, the company should choose RH45.