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Operations Management Week 1 Discussion Questions

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8FINA 301 Capital Budgeting Exercises
Nicholas Bush
Capital Budgeting Exercise 1
You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $1500 initially, and then $400 per year in maintenance costs. Machine B costs $2000 initially, has a life of three years, and requires $300 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 6% and the tax rate is zero. Year | 0 | 1 | 2 | 3 | Machine A's Cash Flows | 1,500 | 400 | 400 | 400 | Machine B's Cash Flows | 2,000 | 300 | 300 | 300 |

Machine A's EAC | 1500 400x3= 1,2001,500+1,200= 2,700 | Machine B's EAC | 2,000 3x300=900 2,000+900= 2,900 |

Which machine do you choose? Explain.

I would take machine A because of the lower overhead cost, and with the lower maintenance cost for each year. Working with a machine that cost less, but preforms equal to machine B.

Capital Budgeting Exercise 2
Your company has spent $250,000 on research to develop a new computer game. The firm is planning to spend $1,400,000 on a machine to produce the new game. Shipping and installation costs for the new machine total $200,000 and these costs will be capitalized and depreciated together with the cost of the machine. The machine will be used for 3 years, has a $200,000 estimated resale value at the end of three years, and will be depreciated straight line over 4 years. Revenue from the new game is expected to be $1,200,000 per year, with costs of $500,000 per year. The firm has a tax rate of 35 percent; a cost of capital (discount rate) of 6 percent, and it expects net working capital (NWC) to increase by $150,000 at the

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