You are working as a finance manager for a construction company. The company is considering to buy a new machine which is expected to boost its revenue. A supplier offered two alternative machinery options for the company’s choice. Each machine will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 10.5%. The cash flows of the projects are provided below.
Machinery option 1
Machinery option 2
Cost
$235,000
$272,000
Future Cash Flows
Year 1
Year 2
Year 3
Year 4
Year 5
85 000
91 000
98 000
94 000
86 000
93 000
95 000
97 000
83 000
Required:
Identify which option of equipment should the company accept based on Profitability Index (PI) method?
Identify which machinery option should the company accept based on simple pay back method if the payback criterion is maximum 2.5 years?
If the company’s management would like to know how much each machinery option can improve the shareholder value, what investment criterion should you use to answer the question?
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