You have been asked to evaluate two machines. The benefits from ownership are identical. Machine A costs $300 to buy and install, lasts for 5 years, and costs $160 per year to operate. Machine B costs $500, lasts for 7 years, and costs $120 per year to operate. Both machines have zero salvage value. Assuming that this is a one-time acquisition, which machine do you recommend if the cost of capital is 15%?
A) Machine A, the PV is $163 more than Machine B.
B) Machine A, the PV of its costs is $163 less than Machine B.
C) Machine A, because the project length is two years less than Machine B.
D) Machine B, the PV is $163 more than Machine A.
E) Machine B, the PV of its costs is $163 less than Machine A.

Question

Quizplus · Accepted Answer

To determine the best choice, we need to calculate the present value (PV) of total costs of each machine.
PV of Machine A = $300 + ($160 / 0.15) * (1 - 1/(1.15^5)) = $940.61
PV of Machine B = $500 + ($120 / 0.15) * (1 - 1/(1.15^7)) = $1103.24
Since we want to choose the machine with the lowest total cost, we should choose Machine A, as its PV of costs is $163 less than Machine B. Therefore, the answer is B.

You Have Been Asked to Evaluate Two Machines