The directors of XYZ Ltd. are considering whether to invest in two separate projects: one is small while the other is large. The company has a cost of capital of 12% (hint: the discount rate).
The directors are considering buying a new machine, which should lead to cost savings. Two machines that are suitable for the business are on the market. These machines have the following outlays and expected cost savings:
Alpha machine Beta machine
Initial outlay (15,000) (30,000)
Cost savings
1 year's time 6,000 8,000
2 years' time 10,000 11,000
3 years' time - 12,000
The business will have a continuing need for whichever machine is chosen.
Required:
Problem 1. Evaluate each machine using both the shortest-common-period-of-time approach and the equivalent-annual-annuity approach. (All workings should be to two decimal places)