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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

REPLACEMENT CHAIN The Fernandez Company has an opportunity to invest in one of two mutually exclusive machines that will produce a product the company will need for the next eight years. Machine A costs $10 million but will provide after-tax inflows of $4 million per year for 4 years. If Machine A were replaced, its cost would be $12 million due to inflation and its cash inflows would increase to $4.2 million due to production efficiencies. Machine B costs $15 million and will provide after-tax inflows of $3.5 million per year for 8 years. If the WACC is 10%, which machine should be acquired? Explain.

Summary Introduction

To Determine: The machine that should be acquired.

Introduction: The replacement chain is a technique of capital budgeting decision model that is utilized to look at least two mutually exclusive capital recommendations with uneven lives.

Explanation

Determine the actual net present value of Machine A

The EAA method cannot be used for Machine A, since the renewal investment changes. Hence the replacement chain method should be used. Even though, this does not judge the way that the machine can be recurring.

Using a excel spreadsheet, the actual net present value of Plane A is determined as $2,679,461.79.

Excel Spreadsheet:

Excel Workings:

Therefore the net present value of Machine A is $2,679,461.79.

Determine the net present value of Machine A using replacement chain

Using a excel spreadsheet, the net present value of Machine A is determined as $3,576,555.48.

Excel Spreadsheet:

Excel Workings:

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