Question

BAK Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn’t equipped to do. Estimates regarding each machine are provided below.
Machine A Machine B
Original cost $78,200 $182,000
Estimated life 8 years 8 years
Salvage value 0 0
Estimated annual cash inflows $19,800 $39,600
Estimated annual cash outflows $5,130 $10,180
Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. (If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answer for present value to 0 decimal places, e.g. 125 and profitability index to 2 decimal places, e.g. 10.50. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
Machine A Machine B
Net present value
Profitablitly index
Machine A Machine B Net present value Profitability index Which machine should be purchased?

Answer 1

Answer:

1. Machine A

Net present value $2,996

Profitability index 1.04

Machine B

Net present value($19,166)

Profitability index = 0.89

B. Machine A

Explanation:

Calculation for the net present value and profitability index of each machine

MACHINE A

NET PRESENT VALUE

Cash Flows×9% Discount Factor=Present value

Present value of net annual cash flows($19,800-$5,130)×5.53482 =$81,196

Present value of salvage value$0 ×0.50187 =$0 $81,196

Capital investment $78,200

Net present value $2,996

($81,196-$78,200)

MACHINE APROFITABILITY INDEX

Profitability index = $81,196 / $78,200

Profitability index = 1.04

MACHINE A

NET PRESENT VALUE

Cash Flows×9% Discount Factor=Present value

Present value of net annual cash flows ($39,600-$10,180) ×5.53482 =$162,834

Present value of salvage value$0 ×0.50187 =$0 $162,834

Capital investment $182,000

Net present value($19,166)

Profitability index = $162,834 / $182,000

Profitability index = 0.89

Therefore the net present value and profitability index of each machine are :

Machine A

Net present value $2,996

Profitability index 1.04

Machine B

Net present value($19,166)

Profitability index = 0.89

2. Based on the above calculation for both Machine And Machine B we can see that Machine B net present value is negative while, profitability index is also low which means that Machine B should not be Purchased and MACHINE A SHOULD BE PURCHASED.