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
Machine A could be purchased for $69,000. It will last 10 years with annual maintenance costs of $2,200 per year. After 10 years the machine can be sold for $7,245.
Machine B could be purchased for $57,500. It also will last 10 years and will require maintenance costs of $8,800 in year three, $11,000 in year six, and $13,200 in year eight. After 10 years, the machine will have no salvage value.

Required:
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. Calculate the present value of Machine A & Machine B. Which machine Esquire should purchase?

Answer 1

Answer:

Esquire should purchase Machine B

Explanation:

Below is the calculation of the present values of Machine A & Machine B.

Machine A             Period    Amount    Present Value Factor   Present Value

Purchase Cost            0         ($69,000)                  1                        ($69,000)

Maintenance Cost    1 - 10      ($2,200)                 6.71008               ($14,762)

Salvage Value             10         $7,245                  0.46319                $3,356

Present Value of A                                                                              ($80,406)

Machine B            Period    Amount     Present Value Factor   Present Value

Purchase Cost            0         ($57,500)                  1                        ($57,500)

Maintenance Cost

Year 3                          3         ($8,800)               0.79383                ($6,986)

Year 6                          6         ($11,000)              0.63017                 ($6.932)

Year 8                          8         ($13,200)             0.54027                 ($7,132)

Present Value of B                                                                            ($78,550)

Note the Following:

1. The Net Present Value of B is lower than the Value of Machine A. So, Machine B should be opted.
2. For the Present Value Factor of Machine A's Maintenance Cost, the 10 year annuity value of 8% was calculated.
3. Machine B has no salvage value after the 10th year period.