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:

Average Common Stockholders' Equity

The average equity held by common shareholders, calculated typically over a year, representing the company's assets minus its liabilities attributable to common shareholders.

Prior Period Adjustment

Adjustments made to the financial statements of a prior period to correct errors or implement changes in accounting policy.

Retained Earnings Account

An equity account on the balance sheet that represents the accumulated net earnings not distributed to shareholders in the form of dividends.

Net Income

The final income of a company, achieved by subtracting expenses and taxes from the total revenues.