You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $100 initially, and then $150 per year in maintenance costs. Machine B costs $200 initially, has a life of three years, and requires $120 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 12% and the tax rate is zero.

Question

Quizplus · Accepted Answer

To determine the present value of each machine, we need to calculate their net present value (NPV). 
NPV of Machine A = -$100 - $150/(1+0.12)^1 - $150/(1+0.12)^2 = -$329.31
NPV of Machine B = -$200 - $120/(1+0.12)^1 - $120/(1+0.12)^2 - $120/(1+0.12)^3 = -$414.32
Since the NPV of Machine B is lower (more negative) than that of Machine A, Machine A is the better choice for the firm.

You Are Considering the Purchase of One of Two Machines