Capital Budgeting Exercise 1

You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $1500 initially, and then $400 per year in maintenance costs. Machine B costs $2000 initially, has a life of three years, and requires $300 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 6% and the tax rate is zero.

Year

0

1

2

3

Machine A's Cash Flows

-1500

-400

-400

Machine B's Cash Flows

-2000

-300

-300

-300

Machine A's EAC

Machine B's EAC

Which machine do you choose? Explain.

(PLEASE SHOW THE EXCEL CALCULATIONS SO I CAN UNDERSTAND THE PROCESS. THANKS!)