A Firm Is Considering the Purchase of One of Two

question 48

Essay

A firm is considering the purchase of one of two machines to replace an existing one.
Machine A will cost $15,000 and has a three-year life. Annual net cash flows are
expected to be $7,000, beginning one year after the machine is purchased. Machine B
will cost $35,000 and has a seven-year life. Annual net cash flows are expected to be
$8,500, beginning one year after the machine is purchased. If the firm's cost of capital
is a constant 14% forever, which machine should it buy? Assume the expected future
cash flows for each machine will remain constant forever.

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Definitions:

Production Possibility Frontier

A curve depicting all maximum output possibilities for two or more goods given a set of inputs (resources), representing the trade-offs of choosing one good over another.

Gains From Trade

The benefits obtained by countries or individuals from engaging in international trade, allowing for specialization and more efficient production.

Fewer Resources

A decrease in the availability of inputs required for production or consumption, often leading to increased competition or prices.

Production Possibility Frontier

A graph that shows the highest possible mix of two goods that can be made with the existing resources and technology.