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 (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Machine A could be purchased for $48,000. It will last 10 years with annual maintenance costs of $1,000 per year. After 10 years the machine can be sold for $5,000. Machine B could be purchased for $40,000. It also will last 10 years and will require maintenance costs of $4,000 in year three, $5,000 in year six, and $6,000 in year eight. After 10 years, the machine will have no salvage value. 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. Ignore income tax considerations. (Negative amounts should be indicated by a minus sign.) Calculate the present value of machine A and machine B?

Answer 1

Answer:

             MACHINE  A

Year Cashflow DF@8%   PV

           $                                       $              

0      (48,000)           1  (48,000)

1-10      (1,000)             6.7101         (6,710)                                                                                        

10          5,000              0.4632      2,316

            PV        (52,394)

MACHINE  B

Year Cashflow DF@8%   PV

           $                                       $              

0     (40,000)           1        (40,000)

3     (4,000)               0.7938     (3,175)                                                                                        

6          (5,000)              0.6302     (3,151)

8          (6,000)              0.5403      (3,242)

                                              PV    (49,568)

           

Explanation:

In this case, the cost of each machine will be considered in year 0 while the maintenance cost will be utilized throughout the life of each machine. The residual value will be considered at the end of useful life of machine A.

All the cashflows will be discounted at 8% throughout the life of each project. The running cost of machine A is discounted at 8% for 8 years using the relevant present value of annuity factor.

The present values are obtained by multiplying the cashflows by the discount factors.                

Answer 2

At the given discounted value factor, present value for machine A is 52,394 and Machine B is 49,568. This can be explained with the help of following table:

• The cost of each machine will be evaluated in year 0 in this example, but the maintenance cost will be considered throughout the equipment's life.
• At the conclusion of machine A's useful life, the residual value will be assessed.

• Throughout the life of each project, all cashflows will be discounted at 8%. Using the relevant present value of annuity factor, the operating cost of machine A is discounted at 8% for 8 years.

Hence it is clear that the cashflows are multiplied by the discount factors to get the present values that is 52,394 for machine A and 49,568 for Machine B

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