(b) A firm is considering a new investment opportunity. The firm must select one of...
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(b) A firm is considering a new investment opportunity. The firm must select one of two possible types of machines to implement the project. Machine A will last for 5 years. Machine B will last for 6 years. The firm intends to operate the project for infinite time, which means that the machines will be replaced once they reached their maximum useful life. Once the type of machine has been selected, it will be replaced with the same type of machine forever. Assume that revenues are received and costs are paid at the end of each year. The project team provided the following estimates:
Detail
Machine A
Machine B
Purchase Price
$150,000
$120,000
Yearly Revenue
$55,000
$60,000
Yearly Costs
$6,000
$3,500
Salvage Value
$5,000
$4,000
Useful Life
5 years
6 years
It has been estimated that the project beta is 0.8, the risk free rate is 3%.p.a, and the market return is 9%.p.a.
Assuming no taxes and no inflation, complete the analysis of the new investment opportunity and provide advice on the best choice of machine to use.
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