# A paint company is considering the purchase

A paint company is considering the purchase of a machine to reduce costs. The savings are expected to generate additional cash flows of \$5,000 per year. The machine costs \$35,000 and is expected to last for 15 years. The company has determined that the cost of capital for such an investment is 12%1. Compute the payback, Net Present Value, and internal rate of return for this machine. Should they purchase it? Assume all cash flows other than the initial purchase occur at the end of the year and do not consider taxes.2. For a \$500 per year addition, the company can get a “Good as New” service that keeps the machine in new condition. Net of the cost of the contract, the machine would produce a cash flow of \$4500 per year in perpetuity. Should they get the service contract?3. Instead of the contract, company engineers have devised a different option to preserve and enhance the capability of the machine over time. By reinvesting 20% of the annual cost savings back into the new machine parts, the engineers can increase the cost savings at a 4% annual rate. For example, at the end of year one, 20% of the \$5,000 cost savings (\$1000) is reinvested in the machine; the net cash flow is thus \$4,000. Next year the cash flow from cost savings grows by 4% to \$5,200 gross, or \$4,160 net, of the 20% reinvestment. As long as the 20% reinvestment continues, the cash flows continue to grow at 4% in perpetuity. What should the company do?The formula for the present value (V) of an initial end-of-year perpetuity payout of \$C (growing at g%) per period, with a discount rate of k%, is: V = C/(k-g)

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