Great Enterprises is analyzing two machines to determine which one they should purchase. The company requires a 13% rate of return and uses straight-line depreciation to a zero book value.
Machine A has a cost of $285,000, annual operating costs of $8,500, and a 3-year life. Machine B
Costs $210,000, has annual operating costs of $14,000, and has a 2-year life. Whichever machine is
Purchased will be replaced at the end of its useful life. Great Enterprises should select machine
_____ because it will save the company about _____ a year in costs.

Question

Quizplus · Accepted Answer

First, we need to calculate the annual cash flows for each machine:

Machine A:
Year 1: -$285,000 - $8,500 = -$293,500
Year 2: -$8,500
Year 3: -$8,500
Total annual cash flows: -$310,500

Machine B:
Year 1: -$210,000 - $14,000 = -$224,000
Year 2: -$14,000
Total annual cash flows: -$238,000

Next, we need to calculate the present value of each machine's cash flows using a 13% discount rate and straight-line depreciation to a zero book value:

Machine A:
PV = (-$293,500/(1+0.13)^1) + (-$8,500/(1+0.13)^2) + (-$8,500/(1+0.13)^3)
PV = -$241,428.19

Machine B:
PV = (-$224,000/(1+0.13)^1) + (-$14,000/(1+0.13)^2)
PV = -$199,775.83

Based on these calculations, Machine A has a lower present value of cash flows, which means it is the less expensive option. Therefore, Great Enterprises should select Machine A.

To calculate the savings in costs, we need to find the difference between the total annual cash flows of each machine:

Savings = Total annual cash flows of Machine B - Total annual cash flows of Machine A
Savings = -$238,000 - (-$310,500)
Savings = $72,500

So, Machine A will save the company about $72,500 per year in costs compared to Machine B. However, this information was not requested in the question, so it is not necessary to provide this answer.

Great Enterprises Is Analyzing Two Machines to Determine Which One