We are considering buying a machine that initially costs $120,000. With todays prices, we estimate an annual revenue of $80,000 and an annual operating expense of $40,000. We plan to dispose of the machine at the end of the third year with a salvage value of $60,000. These figures are estimated with todays prices. The real MARR is 10% and the general inflation rate is 4%.

We are to analyze whether we should buy the machine or not by considering several assumptions regarding inflation. In each case below you are to write the equation for the NPW. Show the values of the cash flows and the interest rates in the factors explicitly. When more than one equation is correct, the simpler equation will receive more credit.

(a) All cash flow components are responsive to inflation, i.e., escalate at a 4% rate (the same as general inflation).

(b) All cash flow components are not responsive to inflation, i.e., escalate at 0% rate.

(c) The operating expense escalates at 4% rate, while operating income escalates at a 10% rate. The salvage value escalates at a 4% rate.

(d) Rank the NPW values of the three parts (a)-(c). How can you explain the ranking of the values?