CASE : (Project Evaluation)
Eureka Manufacturing Ltd has to replace one of its major bottling machines. It is considering two alternative machines. The first available machine is made in Japan and is relatively less costly. The second available machine is made in Germany, is very high-tech but quite costly. However, its expected cost savings is also very high. Both machines come with the same length of manufacturer’s warranty. They will occupy the same amount of space in the factory. The company can only buy one machine this year, but it will not buy both. The net cost savings associated with each machine appear below. The firm discounts any investment project’s cash flows at 15%.
| Year | Japanese Machine | German Machine |
| 0 | -$2,500,000 | -$9,100,000 |
| 1 | 2,000,000 | 3,000,000 |
| 2 | 800,000 | 3,000,000 |
| 3 | 200,000 | 3,000,000 |
| 4 | 200,000 | 3,000,000 |
| 5 | 200,000 | 3,000,000 |
Assignment:
- Eureka has a policy of preferring any investment project that has the comparatively lowest Pay-back period. Based on this criterion, which machine would you recommend for acceptance and why?
- Calculate the net present value (NPV) of each machine and based on this criterion, indicate which project you would recommend for acceptance. Why?
- The internal rate of return (IRR) of which machine is likely to be higher? Can you answer this question just by looking at the cash flow pattern and your answer in (b) above?
- Calculate the profitability index (PI) of each machine and based on this criterion, indicate which machine you would recommend for acceptance.
HINT: Profitability Index = Present value of all cash inflows / Initial Investment
- In your opinion, which machine the company should buy? Are you able to give a clear recommendation? Why?
- Discuss what other non-financial factors the company must consider before making a final decision.
Solution:
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