Raindrip Corp. can purchase a new machine for $1,875,000 that will provide an annual net cash...

Question:

Raindrip Corp. can purchase a new machine for $1,875,000 that will provide an annual net cash flow of $650,000 per year for five years. The machine will be sold for $120,000 after taxes at the end of year five.

What is the net present value of the machine if the required rate of return is 13.5%?

NPV

Net Present Value is a capital budgeting technique used for evaluating projects. It is difference between initial outlay and present value of cash flow.Discount factors are used to determine present value of cash flow.

Answer and Explanation:

{eq}NPV= -Initial Outlay+\displaystyle\frac{FV}{(1+R)^1}+\displaystyle\frac{FV}{(1+R)^2}+\displaystyle\frac{FV}{(1+R)^3}+\displaystyle\frac{FV}{(1+R)^4}+\displaystyle\frac{FV}{(1+R)^5} {/eq}

Where,

R= 0.135

FV for year 1-4 = $650,000

FV for year 5 =$650,000+$120,000 =$770,000

Initial Outlay = $1,875,000

{eq}NPV= -1,875,000+\displaystyle\frac{650,000}{(1+0.135)^1}+\displaystyle\frac{650,000}{(1+0.135)^2}+\displaystyle\frac{650,000}{(1+0.135)^3}+\displaystyle\frac{650,000}{(1+0.135)^4}+\displaystyle\frac{770,000}{(1+0.135)^5} {/eq}

=$447,291.91

Thus, NPV is $447,291.91


Learn more about this topic:

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Cost of Capital: Flotation Cost, NPV & Internal Equity

from Corporate Finance: Help & Review

Chapter 3 / Lesson 18
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