Should they purchase the new machine

[WlND]

Hi, I am working on this problem and I was wondering if someone could check over my work?

Fair corp. operates in the clothing manufacturing industry and currently earns profits of $50 per year. Fair corp has been presented with the option of investing in a new piece of machinery that will allow Fair corp. to earning $100 per year forever (starting one year from now), but will cost the firm $1500 to purchase. Given a discount rate of r=5%, should Fair corp invest in the new machinery?


If they do not invest in the new machinery then they will earn 50/0.05= $1000. If they do purchase the machine then they will earn 100/0.05=2000 but since they have to purchase the machine 2000-1500=$500. Therefore, they should not invest in the new machinery

Thank you for your time

 

[WlND]

(2) However, you are not going to get that $100 now. That cash flow will not start until one year from now. So the perpetuity if you invest will have a present value of $2000 a year from now. Its present value now, at a discount of 5%, is what? You tell me, for right now I am going to say I.

2 000/1.05=1 904.76

3) You were right that that the NET value of the investment is what is relevant. You were also right the NET value is I - C, where C is cost. (Of course you calculated I incorrectly as discussed before, but you had the concept right about looking at the NET value.)

1 904.76-1 500=404.76

(5) However, you have an alternative, namely not investing in the machine. What is that worth? You tell me, but right now let's call the value of the alternative A. If A > (I - C), don't invest. If A < (I - C), invest. If A = (I - C), flip a coin.

50/0.05= $1000
$1000/1.05=952.38

don't invest

 

[WlND]

Thank you for your help