I have the answer in the material but please explain it from the beginning ( the basics0 the basic things like how By spending $300,000 today on a new machine, the firm will reduce costs by $365,000 over five
The manager of Automated Products is contemplating the purchase of a new machine that will cost $300,000 and has a useful life of five years. The machine will yield (year-end) cost reductions to Automated Products of $50,000 in year 1, $60,000 in year 2, $75,000 in year 3, and $90,000 in years 4 and 5. What is the present value of the cost savings of the machine if the interest rate is 8 percent? Should the manager purchase the machine?
ANSWER:
By spending $300,000 today on a new machine, the firm will reduce costs by $365,000 over five
years. However, the present value of the cost savings is only
PV = _5_0_,0_0_0_
1.08
+ _6_0_,0_0_0_
1.08 2
+ _7_5_,0_0_0_
1.08 3
+ _9_0_,0_0_0_
1.08 4
+ _9_0_,0_0_0_
1.08 5
= $284,679
Consequently, the
NPV = PV − C 0 = $284,679 − $300,000 = −$15,321
Since the net present value of the machine is negative, the manager should not purchase the
machine. In other words, the manager could earn more by investing the $300,000 at 8 percent than by
spending the money on the cost-saving technology.
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I have the answer in the material but please explain it from the beginning ( the basics0
the basic things like how By spending $300,000 today on a new machine, the firm will reduce costs by $365,000 over five
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