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The Perez Company has the opportunity to invest in one of two mutually exclusive machines that...

Question:

The Perez 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 $11 million but realizes after-tax inflows of $4 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 $3.5 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 cheaper components used in the machines. The cost of capital is 10.5%. By how much would the value of the company increase if it accepted the better machine?

What is the equivalent annual annuity for each machine?

Net Present Value:

The net present value is the total of the present value of both the cash inflow and cash outflow of the project. The cash outflow is presented as a negative. The NPV method is used in decision making purposes regarding which project would be acceptable. A project with positive NPV will be acceptable, and if all sustained a positive NPV, the project with the higher NPV would be accepted.

Answer and Explanation:

By accepting the better machine, Perez company's value would increase by $793,724.25.

Machine A: $241,616.33

Machine B: $365,869.67

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Evaluating a Budget Using the Net Present Value Method

from Accounting 301: Applied Managerial Accounting

Chapter 14 / Lesson 3
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