A hardness testing machine is being considered for acquisition at a cost of $10,000. Its useful life and salvage value are estimated to be 5 years and $3,000. The annual saving from in-house testing using this machine is likely to be $3,000. Prepare^1 the cashflow table if annual inflation during

Question

A hardness testing machine is being considered for acquisition at a cost of $10,000. Its useful life and salvage value are estimated to be 5 years and $3,000. The annual saving from in-house testing using this machine is likely to be $3,000. [latex]Prepare^{1}[/latex] the cashflow table if annual inflation during the machine’s useful life is projected to be 4%.

Accepted Answer

To prepare the cashflow table, we follow the procedure learned in Chapter 2. The skeleton of the table is as follows, where the first column is for the time period and the second column for the cashflows.

5	4	3	2	1	0	Year
						Cashflow

With the given cost and benefits posted, the cashflow table with no consideration of inflation becomes:

5	4	3	2	1	0	Year
$3,000	$3,000	$3,000	$3,000	$3,000	$10,000	Cashflow

Since inflation’s effect on the cashflows is to be accounted for, we add two more columns for this purpose, and also combine the two cashflows for period 5, as follows. Under the third column we post the inflation factors, while the last column contains the inflationmodified cashflows.

Year	Cashflow	Inflation Factor	Modified Cashflow
0	$10,000
1	$3,000
2	$3,000
3	$3,000
4	$3,000
5	$6,000

Since annual inflation is 4%, the inflation [latex]factor^{2}[/latex] is [latex](1+0.04)^{n}[/latex] , where n is the year.
On posting the given data, the cashflow table looks like:

Year	Cashflow	Inflation Factor	Modified Cashflow
0	-$10,000		-$10,000
1	$3,000	[latex]1.04^{1} [/latex]
2	$3,000	[latex]1.04^{2} [/latex]
3	$3,000	[latex]1.04^{3} [/latex]
4	$3,000	[latex]1.04^{4} [/latex]
5	$6,000	[latex]1.04^{5}[/latex]

Note that the $10,000 cashflow is of now, and hence not modified. Only the future cashflows are modified, by dividing them by their inflation factors. For example, for year 3, inflation-modified cashflow = third-year cashflow/[latex](1+f)^{3}={3,000}/{1.04^{3} } =2,667[/latex] The complete results are in the following table.

Year	Cashflow	Inflation Factor	Modified Cashflow
0	-$10,000		-$10,000
1	$3,000	[latex]1.04^{1} [/latex]	$2,885
2	$3,000	[latex]1.04^{2} [/latex]	$2,774
3	$3,000	[latex]1.04^{3} [/latex]	$2,667
4	$3,000	[latex]1.04^{4} [/latex]	$2,564
5	$6,000	[latex]1.04^{5} [/latex]	$5,466

Question 15.2: A hardness testing machine is being considered for acquisiti...

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