The following data are accumulated by Geddes Company in evaluating the purchase of $158,100 of...

Question:

The following data are accumulated by Geddes Company in evaluating the purchase of $158,100 of equipment, having a four-year useful life:

Net income Net Cash Flow
Year 1 $36,000 $61,000
Year 2 22,000 47,000
Year 3 11,000 35,000
Year 4 (1,000) 24,000

Present Value of $1 at Compound Interest
Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 0.890 0.826 0.797 0.756 0.694
3 0.840 0.751 0.712 0.658 0.579
4 0.792 0.683 0.636 0.572 0.482
5 0.747 0.621 0.567 0.497 0.402
6 0.705 0.564 0..507 0.432 0.335
7 0.665 0.513 0.452 0.376 0.279
8 0.627 0.467 0.404 0.327 0.233
9 0.592 0.424 0.361 0.284 0.194
10 0.558 0.386 0.322 0.247 0.162

a. Assuming that the desired rate of return is 6%, determine the net present value for the proposal. Use the table of the present value of $1 presented above. If required, round to the nearest dollar.

Present value of net cash flow $_____
Amount to the invested $_____
Net present value $_____

Net present value:

The capital budgeting is choosing the best investment option among various alternatives in harmony with companies long term strategies. The net present value calculates the present value of all cash inflows, and the present value of all cash outflow and the project with the largest positive net present value is preferred.

Answer and Explanation:

A) The following information is given about equipment

  • the cash outflow is $158,100 on purchase of equipment
  • the rate of return is 6%
  • The net cash inflows every year for next 4 years are to be taken as the equipment is having a four-year useful life
  • the salvage value is assumed as zero at the end of the investment period

The present value of cash inflows are calculated as below

Net Present value of cash inflows
year Cash   inflows PV   factor of $1 @6% PV   of cash inflows
A B C=   A x B
1 $61,000 0.943 $57,523.00
2 $47,000 0.89 $41,830.00
3 $35,000 0.84 $29,400.00
4 $24,000 0.792 $19,008.00
$147,761.00

The net present value for the proposal is calculated below

Present value of net cash flow $147,761
Amount to be invested $158,100   
Net present value -$10,339

The net present value is -$10,339, and should not be rejected because of negative net present value


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Discounted Cash Flow, Net Present Value & Time Value of Money

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