Question

Your buddy in mechanical engineering has invented a money machine. The main drawback of the machine is that it is slow. It takes one year to manufacture $ 200. ​However, once​ built, the machine will last forever and will require no maintenance. The machine can be built​ immediately, but it will cost $ 2 comma 000 to build. Your buddy wants to know if he should invest the money to construct it. If the interest rate is 11.5 % per​ year, what should your buddy​ do?

Answer 1

Answer: He should decline production of the machine.

Explanation:

Analyzing the problem, we can determine if he should proceed or not by calculating the Net present value. That is present value of the machine in terms of perpetuity as it will be used forever and the cost incurred in its production.

Given the following ;

To manufacture $200 = 1 year, meaning

Amount or yearly payment = $200

Cost of machine = $2,000

Interest rate(r) = 11.5% = 0.115

Recall;

Present the value if perpetuity ;

(Payment per period ÷ rate)

= $200 ÷ 0.115 = $1739.13

Net present value = $1,739.13 - $2000 = - 260.87

Given the negative value of NPV, the cost outweighs the benefit, hence, he should decline.