Solved Question: Dave Metal is examining two options

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Question:

Dave Metal is examining two options – Machine A and Machine B – for a core-cutting machine. Machine A Initial Cost $ 250,000 Savings $28,000/year Maintenance Cost $10,000/year + $0.05/unit Labor $0.25/widget Life 10 years Salvage Value $22,500. Machine B Initial Cost $ 180,000 Savings $22,000/year Maintenance Cost $20,000 /year Labor $0.50/widget Life 5 years Salvage Value $ 17,000. MARR is 12 percent and the company’s sale projection is 30,000 widgets/year. Should either, both or neither machine be purchased? Use both present worth and annual worth comparisons.

Answer:

First we compute the npv normally. To compute equivalent annual worth, divide the npv with the present value annuity factor@12% for the respective years of life of the machines.

Machine A

Particulars Year PVF@12% Amount Present Value
Savings 1-10 5.65022 28000 158206.16
Less : maintenance cost 1-10 5.65022 10000+0.05 x 30000 = 11500 64977.53
Less : labour 1-10 5.65022 30000 x 0.25 = 7500 42376.65
Add: salvage vale 10 0.32197 22500 7244.325
Present value of cash inflows 58096.305
Less : initial cost 0 1 250000 250000
Npv (-)191903.695

Equivalent annual worth = (-)191903.695 / 5.65022 = (-)33963.93

Machine B

Particulars Year PVF@12% Amount Present Value
Savings 1-5 3.60478 22000 79305.16
Less : maintenance cost 1-5 3.60478 20000 72095.60
Less : Labour 1-5 3.60478 0.50 x 30000 = 15000 54071.70
Add : Salvage value 5 0.56743 17000 9646.31
Present value of cash inflows (-)37215.83
Less : initial cost 180000
Npv (-)217215.83

Equivalent annual worth = (217215.83) / 3.60478 = (-)60257.72

Machine A is better among the two as it’s equivalent annual worth is more. However, neither machine is recommended as both have a negative NPV and annual worth.

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