Reference no: EM132466480

A manufacturer is considering two alternative machine replacements. Machine ABC costs $1 million with an expected life of 5 years and will generate after-tax cash flows of $350,000 a year. At the end of 5 years, the salvage value on Machine ABC is zero, but the company will be able to purchase a replacement Machine ABC for a cost of $1.2 million. The replacement Machine ABC will generate after-tax cash flows of $375,000 a year for another 5 years. At that time its salvage value will also be zero. The manufacturer's second option is to buy Machine XYZ at a cost of $1.5 million today. Machine XYZ will produce after-tax cash flows of $400,000 a year for 10 years, and after 10 years it will have an after-tax salvage value of $100,000. The cost of capital for both machines is 12%.

1. What is the NPV for both machine ABC and for machine?
2. Which machine will have the highest NPV for the firm?
3. Please explain how the selection of the machine with the highest NPV will increase the value of the firm.
4. If the manufacturer chooses the machine that adds the most value to the firm, by how much will the company's value increase?

What is the best option and why?