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 percent and the tax rate is zero.

Question

Quizplus · Accepted Answer

To determine the better machine, we need to calculate the present value of the costs associated with each machine. For Machine A, the initial cost is $100 and the maintenance costs are $150 per year for two years, so the total cost is $100 + ($150 × 2) = $400. Using a discount rate of 12 percent, the present value of these costs is:

$400 ÷ (1 + 0.12)² = $277.72

For Machine B, the initial cost is $200 and the maintenance costs are $120 per year for three years, so the total cost is $200 + ($120 × 3) = $560. Using a discount rate of 12 percent, the present value of these costs is:

$560 ÷ (1 + 0.12)³ = $336.21

Therefore, Machine B is the better choice because it has a lower present value of costs.

You Are Considering the Purchase of One of Two Machines