Using payback, ARR, and NPV with unequal cash flows Medeiros Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machine at a cost of $1,000,000. If refurbished, Medeiros expects the machine to last another 7 years and then have no residual value. Option 2 is to replace the machine at a cost of $2,000,000. A new machine would last 9 years and have no residual value. Medeiros expects the following net cash inflows from the two options:

 

Medeiros uses straight-line depreciation and requires an annual return of 10%.

Requirements

• 1. Compute the payback, the ARR, the NPV, and the profitability index of these two options.
• 2. Which option should Medeiros choose? Why?

Refurbish Current Purchase Year Machine New Machine $ 450,000 $ 650,000 2 350,000 550,000 250,000 450,000 4 150,000 350,000 100,000 300,000 100,000 300,000 100,000 300,000 8. 300,000 300,000 Total $ 1,500,000 $ 3,500,000 Refurbish Current Purchase Year Machine New Machine $ 450,000 $ 650,000 2 350,000 550,000 250,000 450,000 4 150,000 350,000 100,000 300,000 100,000 300,000 100,000 300,000 8. 300,000 300,000 Total $ 1,500,000 $ 3,500,000 Refurbish Current Purchase Year Machine New Machine $ 450,000 $ 650,000 2 350,000 550,000 250,000 450,000 4 150,000 350,000 100,000 300,000 100,000 300,000 100,000 300,000 8. 300,000 300,000 Total $ 1,500,000 $ 3,500,000 Refurbish Current Purchase Year Machine New Machine $ 450,000 $ 650,000 2 350,000 550,000 250,000 450,000 4 150,000 350,000 100,000 300,000 100,000 300,000 100,000 300,000 8. 300,000 300,000 Total $ 1,500,000 $ 3,500,000