Answer:
A. If the WACC is 9%, which machine should be acquired?
- Since machine B's NPV is higher, it should be acquired. Even though machine A's IRR is higher, the NPV is always the first and most important parameter to consider.
B. By how much would the value of the company increase if it accepted the better machine?
- if machine B is acquired, then company's value will be $743,518 (= $11,879,562 - $11,136,044) higher than if machine A was acquired.
C. What is the equivalent annual annuity for each machine?
- EAA machine A = $2,011,998
- EAA machine B = $2,146,333
Explanation:
we need to determine the NPV of each investment project:
Machine A:
initial investment -$8,900,000
NCF 1 $4,500,000
NCF 2 $4,500,000
NCF 3 $4,500,000
NCF 4 $4,500,000 - $9,800,000 = -$5,300,000
NCF 5 $4,700,000
NCF 6 $4,700,000
NCF 7 $4,700,000
NCF 8 $4,700,000
WACC = 9%
using an excel spreadsheet to calculate the NPV = $11,136,044
, IRR = 35.74%
equivalent annual annuity (EAA) = (r x NPV) / [1 - (1 + r)⁻ⁿ]
- r = 9%
- NPV = $11,136,044
- n = 8
EAA = (0.09 x $11,136,044) / [1 - (1 + 0.09)⁻⁸] = $1,002,244 / 0.4981 = $2,011,998
Machine B:
initial investment -$13,900,000
NCF 1 $4,300,000
NCF 2 $4,300,000
NCF 3 $4,300,000
NCF 4 $4,300,000
NCF 5 $4,300,000
NCF 6 $4,300,000
NCF 7 $4,300,000
NCF 8 $4,300,000
WACC = 9%
using an excel spreadsheet to calculate the NPV = $11,879,562
, its IRR = 27.42%
equivalent annual annuity (EAA) = (r x NPV) / [1 - (1 + r)⁻ⁿ]
- r = 9%
- NPV = $11,879,562
- n = 8
EAA = (0.09 x $11,879,562) / [1 - (1 + 0.09)⁻⁸] = $1,069,161 / 0.4981 = $2,146,333
