Miles, Inc. is considering the purchase of a new machine for $600,000 that has an estimated useful life of 5 years and no salvage value. The machine will generate net annual cash flows of $105,000. It is believed that the new machine will reduce downtime because of its reliability. Assume the discount rate is 8%. In order to make the project acceptable, the reduction in downtime must be worth $\begin{array}{lrr}& \text { Present Value } & \text { PV of an Annuity } \
\text { Year } & \text { of } 1 \text { at } 8 \% & \text { of } 1 \text { at } 8 \% \
1 & .926 & .926 \
2 & .857 & 1.783 \
3 & .794 & 2.577 \
4 & .735 & 3.312 \
5 & .681 & 3.993
\end{array}$

Question

Quizplus · Accepted Answer

The net present value (NPV) of the machine's cash flows needs to equal the purchase price to make the project acceptable. The present value of the annuity of $105,000 over 5 years at 8% is $105,000 * 3.993 (from the table) = $419,265. The difference between the purchase price ($600,000) and the present value of the cash flows ($419,265) is $180,735. This amount needs to be covered by the reduction in downtime over 5 years. To find the annual value, divide $180,735 by the PV of an annuity factor for 5 years at 8% (3.993), which gives approximately $36,147 per year.

Miles, Inc A) $23,958 Per Year