Marvec needs to replace an extruder and two replacements look good. Extruder A costs $102,000 and has a 10-year life. Extruder B costs only $56,000, but its expected life is 6 years. Extruder A will generate net cash flows of $17,600 per year for 10 years and B will generate net cash flows of $13,800 per year for 6 years. If Marvec's cost of capital is 11%, which extruder should be chosen and what is its NPV? Use equivalent annual annuities.
A) Extruder B, $564
B) Extruder B, $2,388
C) Extruder A, $1,646
D) Extruder A, $280

Question

Quizplus · Accepted Answer

To determine the best option, we need to calculate the equivalent annual annuity (EAA) for each extruder. This is the annual cash inflow that would result in the same present value as the initial cost of each extruder.

For Extruder A: 
PV = -$102,000 
n = 10 
r = 11% 
Using a financial calculator, we find the EAA to be $17,110.

For Extruder B: 
PV = -$56,000 
n = 6 
r = 11% 
Using a financial calculator, we find the EAA to be $14,079.

So Extruder A has a higher EAA, but we also need to consider the NPV of each option.

For Extruder A: 
PV = -$102,000 
n = 10 
r = 11% 
PMT = $17,600 
Using a financial calculator, we find the NPV to be $1,646.

For Extruder B: 
PV = -$56,000 
n = 6 
r = 11% 
PMT = $13,800 
Using a financial calculator, we find the NPV to be $2,388.

Since Extruder B has the higher NPV, it is the better choice. The answer is B, Extruder B with an NPV of $2,388.

Marvec Needs to Replace an Extruder and Two Replacements Look