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7 August, 09:44

Your buddy in mechanical engineering has invented a money machine. The main drawback of the machine is that it is slow. It takes one year to manufacture $100. However, once built, the machine will last forever and will require no maintenance. The machine can be built immediately, but it will cost $1,000 to build. Your buddy wants to know if he should invest the money to construct it. If the interest rate is 9.5% per year. a. What should your buddy do? b. What is your advice if the machine takes one year to build?

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  1. 7 August, 11:19
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    a) We shall calculate the NPV of the project. If it is positive, then money can be invested

    Cash outflow in the beginning = 1000

    Present value of perpetual annuity of 100 at 9.5 %

    100 /.095

    = 1052.63

    which is more than initial cash outflow

    So NPV is positive

    Hence money can be invested.

    b)

    If machine takes one year to build, first year cash outflow of 100 will be absent

    Present value of 100 after 1 year

    = 100 / 1.095

    = 91.32

    So present value of annuity

    = 1052.63 - 91.32

    = 961.31

    This is less than 1000 so

    NPV is negative.

    Hence money can not be invested.
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