A company is evaluating the investment in new machinery to manufacture a new product. 2 alternatives (Machine A and Machine B) are being considered.

Estimates for the two machines are:

Machine A

Initial cost = $800,000

Useful life = 5 years

Residual value at the end of 5 years = $120,000

Annual profits (net of straight line depreciation) = $100,000

Machine B

Initial cost = $760,000

Useful life = 5 years

Residual value at the end of 5 years = $60,000

Annual profits (net of straight line depreciation) = $80,000

The company has a cost of capital of 12% per annum.

Discount factors:

Year 1:

10% = 0.909

12% = 0.893

15% = 0.870

20% = 0.833

Year 2:

10% = 0.826

12% = 0.797

15% = 0.756

20% = 0.694

Year 3:

10% = 0.751

12% = 0.712

15% = 0.658

20% = 0.579

Year 4:

10% = 0.683

12% = 0.636

15% = 0.572

20% = 0.482

Year 5:

10% = 0.620

12% = 0.567

15% = 0.497

20% = 0.402

Required:

(a) Evaluate each machine using the following methods:

(i) Payback

(ii) Net present value

(iii) Internal rate of return

(iv). Profitability index

(b) Recommend with reasons which machine, the company should purchase.