You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $100,000 to purchase and which will have OCF of -$7,000 annually throughout the machine's expected life of three years; and machine B, which will cost $125,000 to purchase and which will have OCF of -$2,600 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 15 percent, which one should you choose?

Question

Quizplus · Accepted Answer

To choose the least expensive machine, we need to calculate the present value of the cash flows for each machine and choose the one with the lower present value.

For Machine A:

PV = -$100,000 + (-7,000/1.15) + (-7,000/1.15^2) + (-7,000/1.15^3)
PV = -$100,000 - $5,434 - $4,731 - $4,121
PV = -$114,286

For Machine B:

PV = -$125,000 + (-2,600/1.15) + (-2,600/1.15^2) + (-2,600/1.15^3) + (-2,600/1.15^4)
PV = -$125,000 - $2,260 - $1,966 - $1,709 - $1,483
PV = -$132,417

Therefore, Machine B has the lower present value and is the least expensive choice.

You Are Trying to Pick the Least-Expensive Machine for Your