question archive The Andrew Jackson Company has the opportunity to invest in one of two mutually exclusive machines that will produce a product it will need for the foreseeable future
The Andrew Jackson Company has the opportunity to invest in one of two mutually exclusive machines that will produce a product it will need for the foreseeable future
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The Andrew Jackson Company has the opportunity to invest in one of two mutually exclusive machines that will produce a product it will need for the foreseeable future. Machine A costs $10 million but realizes after-tax inflows of $4.5 million per year for 4 years. After 4 years, the machine must be replaced. Machine B costs $16 million and realizes after-tax inflows of $4 million per year for 8 years, after which it must be replaced. Assume that machine prices are not expected to rise because inflation will be offset by caper components used in the machines. If the cost of capital is 10 percent, which machine should the company use? Show all work.
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Machine A:
Cost of Machine = $10,000,000
Annual Cash Inflow = $4,500,000
Useful Life = 4 years
NPV = -$10,000,000 + $4,500,000 * PVIFA(10%, 4)
NPV = -$10,000,000 + $4,500,000 * 3.169865
NPV = $4,264,392.50
EAC = NPV / PVIFA(10%, 4)
EAC = $4,264,392.50 / 3.169865
EAC = $1,345,291.52
Machine B:
Cost of Machine = $16,000,000
Annual Cash Inflow = $4,000,000
Useful Life = 8 years
NPV = -$16,000,000 + $4,000,000 * PVIFA(10%, 8)
NPV = -$16,000,000 + $4,000,000 * 5.334926
NPV = $5,339,704
EAC = NPV / PVIFA(10%, 8)
EAC = $5,339,704 / 5.334926
EAC = $1,000,895.61
So, you should prefer Machine A as its EAC is less than that of Machine B.
