Question
Your company is growing rapidly and now you need to make an investment decision of whether install the newest, state of the art machine for
Your company is growing rapidly and now you need to make an investment decision of whether install the newest, state of the art machine for production. The up front cost for the machine is $700,000. This year the machine will generate no revenue because it takes the whole year to install it. In the first year of revenue, the machine will generate $120,000 of revenue. As the new machine ages, it will begin to see wear and tear and will produce 5% less output each year (in other words, it will depreciate 5% each year).The company's treasury department tells you that if we invested the $700,000 elsewhere, you could earn 7% each year (in other words, the real interest rate is 7%).
a)Find the present value of future revenue for the first 2 years following the installation.
b)Find the present value of the stream of payments. Should you install the new machine? Why?
c)Find the user cost of capital for the new machine. Should you install the new machine?
Why?
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