Tags
#analyst-notes #cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10 #subject-3-investment-criteria
Question
You have been asked to evaluate two machines. The benefits from ownership are identical. Machine A costs $150 to buy and install, lasts for 5 years, and costs$80 per year to operate. Machine B costs $250, lasts for 7 years, and costs$60 per year to operate. Both machines have zero salvage value. Assuming that this is a one-time acquisition, which machine do you recommend if the cost of capital is 10%?

A. Machine A, because the PV of its costs is $88.85 less than Machine B. B. Machine B, because the PV of its costs is$20 less than Machine A.
C. Machine A, even though the PV of its costs is equal to that of Machine B.

PVA = 150 + 80(3.7908) = 150 + 303.26 = 453.26
PVB = 250 + 60(4.8684) = 250 + 292.10 = 542.10
PVB > PVA

Tags
#analyst-notes #cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10 #subject-3-investment-criteria
Question
You have been asked to evaluate two machines. The benefits from ownership are identical. Machine A costs $150 to buy and install, lasts for 5 years, and costs$80 per year to operate. Machine B costs $250, lasts for 7 years, and costs$60 per year to operate. Both machines have zero salvage value. Assuming that this is a one-time acquisition, which machine do you recommend if the cost of capital is 10%?

A. Machine A, because the PV of its costs is $88.85 less than Machine B. B. Machine B, because the PV of its costs is$20 less than Machine A.
C. Machine A, even though the PV of its costs is equal to that of Machine B.
?

Tags
#analyst-notes #cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10 #subject-3-investment-criteria
Question
You have been asked to evaluate two machines. The benefits from ownership are identical. Machine A costs $150 to buy and install, lasts for 5 years, and costs$80 per year to operate. Machine B costs $250, lasts for 7 years, and costs$60 per year to operate. Both machines have zero salvage value. Assuming that this is a one-time acquisition, which machine do you recommend if the cost of capital is 10%?

A. Machine A, because the PV of its costs is $88.85 less than Machine B. B. Machine B, because the PV of its costs is$20 less than Machine A.
C. Machine A, even though the PV of its costs is equal to that of Machine B.

PVA = 150 + 80(3.7908) = 150 + 303.26 = 453.26
PVB = 250 + 60(4.8684) = 250 + 292.10 = 542.10
PVB > PVA
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#### Parent (intermediate) annotation

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dy>NPV measures the dollar benefit of the project to shareholders. However, it does not measure the rate of return of the project, and thus cannot provide "safety margin" information. Safety margin refers to how much the project return could fall in percentage terms before the invested capital is at risk.<body><html>

#### Original toplevel document

Subject 3. Investment Decision Criteria
on that capital. If a firm takes on a project with a positive NPV, the position of the stockholders is improved. Decision rules: The higher the NPV, the better. Reject if NPV is less than or equal to 0. <span>NPV measures the dollar benefit of the project to shareholders. However, it does not measure the rate of return of the project, and thus cannot provide "safety margin" information. Safety margin refers to how much the project return could fall in percentage terms before the invested capital is at risk. Assuming the cost of capital for the firm is 10%, calculate each cash flow by dividing the cash flow by (1 + k) t where k is the cost of capital and t is the year number.

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