The equipment below is required for your business. Assume each will be replaced as it wears out. The required return is 15%. Ignore taxes. Which machine should you buy and why?

Question

The equipment below is required for your business. Assume each will be replaced as it wears out. The required return is 15%. Ignore taxes.  Which machine should you buy and why?

Quizplus · Accepted Answer

Machine A:
Initial cost: $50,000
Annual operating cost: $10,000
Salvage value: $15,000
Life: 5 years
Discount rate: 15%

NPV = -$50,000 + ($15,000/1.15^5) - ($10,000/0.15 x (1 - 1/1.15^5)) = -$6,756.78

Machine B:
Initial cost: $65,000
Annual operating cost: $7,500
Salvage value: $20,000
Life: 7 years
Discount rate: 15%

NPV = -$65,000 + ($20,000/1.15^7) - ($7,500/0.15 x (1 - 1/1.15^7)) = $24,152.07

Machine B has a higher NPV and effectively costs less to operate each year than Machine A. Therefore, the best choice is Machine B.

The Equipment Below Is Required for Your Business