Decision Making In deciding whether to replace the old machine with a new one, several factors need to be considered. The key considerations include the initial cost of the new machine, the cash inflows from both the old and new machines, the time value of money, and the overall impact on the company's profitability. Cash Flows and Costs The old machine is expected to generate a cash inflow of $5,000 per year for 3 years. Therefore, the total cash inflow from the old machine over the next 3 years would be $15,000. On the other hand, the new machine costs $20,000 but is expected to generate a cash inflow of $10,000 per year for 4 years, resulting in a total cash inflow of $40,000 over its useful life. Net Present Value (NPV) Analysis To make an informed decision, it is essential to calculate the net present value (NPV) of both options. NPV takes into account the time value of money by discounting future cash flows to their present value using an appropriate discount rate. In this case, we can use the company's cost of capital as the discount rate. The NPV of the old machine can be calculated as follows: NPV = $5,000 / (1 + r) + $5,000 / (1 + r)^2 + $5,000 / (1 + r)^3 Where r is the discount rate. Similarly, the NPV of the new machine can be calculated as: NPV = -$20,000 + $10,000 / (1 + r) + $10,000 / (1 + r)^2 + $10,000 / (1 + r)^3 + $10,000 / (1 + r)^4 By comparing the NPV of both options, we can determine which investment provides a higher return after considering the time value of money. Consideration of Payback Period Another important factor to consider is the payback period. The payback period indicates how long it takes for an investment to recoup its initial cost. In this case, if the company has a specific payback period target, it should be taken into account when making the decision. Risk and Uncertainty It's also crucial to consider any risks associated with each option. For example, if there is uncertainty about future cash flows or if there are potential technological advancements that could make the new machine obsolete sooner than expected, these factors should be factored into the decision-making process. Sensitivity Analysis Conducting sensitivity analysis can help assess how changes in key variables such as cash inflows, discount rates, or useful life of the machines would impact the decision. This analysis provides insights into the robustness of the decision under different scenarios. Conclusion Based on a comprehensive analysis considering NPV, payback period, risk assessment, and sensitivity analysis, a decision can be made regarding whether to replace the old machine with a new one. Benefits and Costs The benefits of replacing the old machine with a new one include increased efficiency and higher cash inflows over its useful life. However, this comes with the cost of purchasing a new machine and potential risks associated with technological advancements or unforeseen changes in cash flows. Final Decision After conducting a thorough analysis and considering all relevant factors including NPV, payback period, risk assessment, and sensitivity analysis, it is recommended to replace the old machine with a new one. The higher cash inflows generated by the new machine over its useful life outweigh its initial cost and provide greater long-term profitability for the company