Johnson Jets is considering two mutually exclusive machines. Machine A has an up-front cost of $100,000 (CF0 = -100,000) and produces positive after-tax cash inflows of $40,000 a year at the end of each of the next six years.
Machine B has an up-front cost of $50,000(CF0 = -50,000) and produces after-tax cash inflows of $30,000 a year at the end of the next three years. After three years, Machine B can be replaced at a cost of $55,000 (paid at t = 3). The replacement machine will produce after-tax cash inflows of $32,000 a year for three years (inflows received at t = 4, 5, and 6).
The company's cost of capital is 10.5 percent. What is the net present value (on a 6-year extended basis) of the most profitable machine?
We find the NPV of both the options.
Option 1 the cash flows are
Year 0 1 2 3 4 5 ...
The solution explains the calculation of Net Present Value given the cash flows