Answer:
(a) What is the net present value of this potential investment?
Net present value of Investment is $(3,903)
(b) Should you invest in this machine?
We should not invest in this investment because Net present value of this investment is negative by discounting Minimum acceptable rate of return.
Explanation:
Present Values:
Revenue $144,146
O&M Cost ($48,049)
Initial Investment $(100,000)
Net Present value $(3,903)
Working :
Present Value Calculation = P x ( (1- ( 1 + r )^-10) / r
Revenue = $21,000 x ( (1- ( 1 + 0.075 )^-10) / 0.075 = 144,146
O&M Costs = $7,000 x ( (1- ( 1 + 0.075 )^-10) / 0.075 = 48,049
Answer:
A) NPV = -1669.6
B) Since this value is negative, the machine should not be invested in because the cash outflow is greater than the inflow.
Explanation:
The question is to determine whether we should invest in the machine or not using the net present value formula for calculation as follows:
Step 1: We determine the Net present Value of the annual receipts
=The Revenue expected yearly - the Costs incurred yearly
= $21,000 - $7,000
= $14,000
Based on this estimated amount, we then determine the present values of the cash flow as follows
To do this, we use the Present Value Interest Factors for a One-Dollar Annuity Table
We use 7% annual rate and 10 year period. We plug this into the table and get 7.0236
Also, using this formula we arrive at the same figure PVIFA = [1 - 1/(1 + k)n] / k
Based on the figure:
The present Value of the cash flow for 10 years
= $14,000 x (the Present Value of Annuity determined above)
= $14,000 x 7.0236
= $98,330.4
Finally, the Net present Value
= The Present Value of Cash inflows - The initial cost of the machine
= $98,330.4 - $100,000
= -1669.6
Since this value is negative, the machine should not be invested in because the cash outflow is greater than the inflow.
