Question
Young Industries is considering the purchase of a new machine for the production of basketballs. The company has a choice of two different machines with
Young Industries is considering the purchase of a new machine for the production of basketballs. The company has a choice of two different machines with differing economic lives. Given that Young is in the business of manufacturing and selling basketballs, the machine chosen will be replaced perpetually at the end of its economic life (with the same type of machine). Young depreciates equipment on a straight-line basis with zero salvage value. Machine 1 costs $100,000 and will have an economic life of four years. Machine 2 costs $120,000 and will have an economic life of five years. Both machines will allow the company to generate incremental sales revenue of $110,000 per year. Machine 1 will have incremental variable costs of 50% of sales and incremental fixed costs of $10,000 annually. Machine 2 will have incremental variable costs of 48% of sales and incremental fixed costs of $48,000 annually. The companys tax rate is 20%, and the required return on this capital budgeting project is 7%.
a. Which of these two machines generates a higher net present value?
b. Why Is it not appropriate to compare the net present values (NPVs) of these projects to decide which machine to purchase?
c. Which machine should be purchased?
d. Show the numbers you used to make your choice in c.
Please show your work.
Thanks for any help!
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