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2. The company is choosing between machine A and B (they are mutually exclusive and the company can only pick one). The initial cost of machine A is $1,400,000 and it will last for 7 years before it needs to be replaced. The cost of operating machine A each year is $150,000. The initial cost of Machine B is $800,000 and it will last for 5 years before it needs to be replaced. The cost of operating machine B is $230,000 in cash flow per year. If the required rate of return is 10%,

(a) Calculate the 7 year and 5 year annuity factors at 10% annual interest.

(b) Using the annuity factors, find the PV of Machine A and Machine B including all costs (initial + operating).

(c) Which machine is a better choice for the company after considering the different lives of the projects? (Note: be sure to use the equivalent annual annuity method)

3. BMT has developed a new product. It can go into production for an initial investment of $4,400,000. The equipment will be depreciated using straight-line depreciation over 4 years to a value of zero. The firm believes that net working capital at each date will equal 25 percent of next years forecast sales. The firm estimates that variable costs are equal to 40% of sales and fixed costs are $600,000 per year. Sales forecasts in dollars are below. The project will come to an end after 4 years, when the product becomes obsolete. The firms tax rate is 35 percent, and the discount rate is 9 percent. Calculate the NPV.

Year 0 1 2 3 4

Sales forecast (in $): 0 3,200,000 3,600,000 4,000,000 4,400,000

4. In problem 3, perform scenario analysis by assuming the following changes take place at the same time. Find the revised NPV.

(a) sales are 10% lower each year than predicted above

(b) the discount rate is 8 percent

(c) variable costs are 45% of sales