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 $27,000. It will last 10 years with annual maintenance costs of $900 per year. After 10 years the machine can be sold for $2,835.
Machine B could be purchased for $22,500. It also will last 10 years and will require maintenance costs of $3,600 in year three, $4,500 in year six, and $5,400 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 because it has a lower present value.

Explanation:

Present value cost of Machine A:

= Initial investment + Present value of costs - Present value of sales amount

Present value of cost = 900 * Present value annuity factor, 10 years, 8%

= 900 * 6.7101

= $6,039

Present value of sales amount = 2,835 / (1 + 8%)¹⁰

= $1,313.15

Present value cost = 27,000 + 6,039 - 1,313.15

= $31,725.85

Present value of Machine B:

= 22,500 + 3,600 / 1.08³ + 4,500 / 1.08⁶ + 5,400 / 1.08⁸

= 30,198.18

Esquire should purchase Machine B