Consider a Machine That Costs $20 000,has an Estimated Useful

question 37

Multiple Choice

Consider a machine that costs $20 000,has an estimated useful life of five years with cash flows of $10 000 p.a.and a cost of capital of 10% p.a.A company is considering whether the machine should be replaced every one,two,three,four or five years.The net present value (assuming constant chain of replacement) under each alternative is given as follows:
NPV(1) = $20 000
NPV(2) = $29 000
NPV(3) = $35 000
NPV(4) = $25 000
NPV(5) = $19 000
What is the appropriate action for the firm?

• A)Go ahead with the project.
• B)Do not go ahead with the project.
• C)Go ahead with the project and replace the machine every five years.
• D)Go ahead with the project and replace the machine every three years.

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Definitions:

Straight-Line Method

A depreciation method that allocates an asset's cost evenly over its useful life.

Accrued Interest

Interest that has been incurred but not yet paid, typically reported as a liability on the balance sheet until it is paid out.

Premiums

Additional amounts paid over the normal cost or value, often related to insurance policies or bond prices above their face value.

Discounts

Reductions to the selling price of goods or services that can be applied for various reasons, such as to encourage prompt payment or to move inventory quickly.