Ford is a large car manufacturing firm considering replacing one of its painting machines with either...

 

  
 

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Ford is a large car manufacturing firm considering replacing one of its painting machines with either of two new machines: machine A or machine B. Machine A is a highly automated and computer- controlled machine; machine B is a less expensive machine that uses standard technology. To analyse these alternatives, Steve Ellis, a financial analyst, prepared estimates of the initial investment and incremental (relevant) after-tax net cash flows associated with each machine. These are presented inthe following table: Initial investment Year 1 2 $200,000 300,000 400,000 600,000 5 850,000 Note that Steve plans to amortise (depreciate) both machine over a five-year period. At the end of that time, machine A would have a large salvage value, thus accounting for the large fifth-year net cash flow for machine A. 3 Machine B $600,000 Net cash inflows $320,000 210,000 120,000 90,000 80,000 4 Machine A $1,500,000 Mark believes that both machines are equally risky and that acceptance of either of them will not change firm's overall risk. He therefore decides to apply the firm's 12% cost of capital when evaluating the machines. The firm requires all projects to have a maximum payback period of four years. Ford is a large car manufacturing firm considering replacing one of its painting machines with either of two new machines: machine A or machine B. Machine A is a highly automated and computer- controlled machine; machine B is a less expensive machine that uses standard technology. To analyse these alternatives, Steve Ellis, a financial analyst, prepared estimates of the initial investment and incremental (relevant) after-tax net cash flows associated with each machine. These are presented inthe following table: Initial investment Year 1 2 $200,000 300,000 400,000 600,000 5 850,000 Note that Steve plans to amortise (depreciate) both machine over a five-year period. At the end of that time, machine A would have a large salvage value, thus accounting for the large fifth-year net cash flow for machine A. 3 Machine B $600,000 Net cash inflows $320,000 210,000 120,000 90,000 80,000 4 Machine A $1,500,000 Mark believes that both machines are equally risky and that acceptance of either of them will not change firm's overall risk. He therefore decides to apply the firm's 12% cost of capital when evaluating the machines. The firm requires all projects to have a maximum payback period of four years.