You are working as a finance manager for a construction company. The company is considering to buy a new machine which is expected to boost its revenue. A supplier offered two alternative machinery options for the company’s choice. Each machine will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 10.5%. The cash flows of the projects are provided below. Machinery option 1 Machinery option 2 Cost $235,000 $272,000 Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 85 000 91 000 98 000 94 000 86 000 93 000 95 000 98 000 97 000 83 000 Required: Identify which option of equipment should the company accept based on Profitability Index (PI) method? Identify which machinery option should the company accept based on simple pay back method if the payback criterion is maximum 2.5 years? If the company’s management would like to know how much each machinery option can improve the shareholder value, what investment criterion should you use to answer the question?
You are working as a finance manager for a construction company. The company is considering to buy a new machine which is expected to boost its revenue. A supplier offered two alternative machinery options for the company’s choice. Each machine will last 5 years and have no salvage value at the end. The company’s required rate of
|
|
Machinery option 1 |
Machinery option 2 |
|
Cost |
$235,000 |
$272,000 |
|
Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 |
85 000 91 000 98 000 94 000 86 000 |
93 000 95 000 98 000 97 000 83 000 |
Required:
Identify which option of equipment should the company accept based on Profitability Index (PI) method?
Identify which machinery option should the company accept based on simple pay back method if the payback criterion is maximum 2.5 years?
If the company’s management would like to know how much each machinery option can improve the shareholder value, what investment criterion should you use to answer the question?
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