Question

Esquire Company needs to acquire a molding machine to be used in its manufacturing process. Two types of machines that would be appropriate are presently on the market. The company has determined the following: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)
Machine A could be purchased for $63,000. It will last 10 years with annual maintenance costs of $2,000 per year. After 10 years the machine can be sold for $6,615.
Machine B could be purchased for $52,500. It also will last 10 years and will require maintenance costs of $8,000 in year three, $10,000 in year six, and $12,000 in year eight. After 10 years, the machine will have no salvage value.

Required:
a. Assume an interest rate of 8% properly reflects the time value of money in this situation and that maintenance costs are paid at the end of each year. Ignore income tax considerations.
b. Calculate the present value of Machine A & Machine B. Which machine Esquire should purchase?

Answer 1

Answer:

Esquire should purchase machine B since its present value is lower than machine B's ($69,917.73 < $73,356.18)

Explanation:

Machine A:

PV of purchase cost $63,000

PV of maintenance costs = $2,000 x 6.7101 (PV annuity factor, 10 periods, 8%) = $13,420.20

PV of resale value = -$6,615 / 1.08¹⁰ = -$3,064.02

total PV = $63,000 + $13,420.20 - $3,064.02 = $73,356.18

Machine B:

PV of purchase cost $52,500

PV of maintenance costs:

• $8,000 / 1.08³ = $6,350.66
• $10,000 / 1.08⁶ = $6,301.70
• $12,000 / 1.08⁸ = $4,765.37

total PV = $69,917.73