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:
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.
Required:
Determine which machine Esquire should purchase. 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.
Answer:
Choose the option with the lowest present value of cash outflows, net of the present value of any cash
inflows (Cash outflows are shown as negative amounts; cash inflows as positive amounts).
Machine A:
PV = – $48,000 – 1,000 (6.71008) + 5,000 (.46319)
Present value of an ordinary annuity of $1: n = 10, i = 8% (from Table 4)
Present value of $1: n = 10, i = 8% (from Table 2)
PV = – $48,000 – 6,710 + $2,316
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:
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.
Required:
Determine which machine Esquire should purchase. 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.
Answer:
Choose the option with the lowest present value of cash outflows, net of the present value of any cash
inflows (Cash outflows are shown as negative amounts; cash inflows as positive amounts).
Machine A:
PV = – $48,000 – 1,000 (6.71008) + 5,000 (.46319)
Present value of an ordinary annuity of $1: n = 10, i = 8% (from Table 4)
Present value of $1: n = 10, i = 8% (from Table 2)
PV = – $48,000 – 6,710 + $2,316
