A U.S. manufacturer of particleboard furniture is considering investing in a new
ID: 1093057 • Letter: A
Question
A U.S. manufacturer of particleboard furniture is considering investing in a new stamping machine. The machine is expected to have a useful life of five years, after which the machine can be sold as scrap for an estimated $5,000. The firm plans to issue bonds to pay for the machine and intends to treat the interest rate on the bonds as the relevant discount rate for evaluating the project. The machine will cost the firm $175,000, all of which must be paid at the beginning of the project. The new stamping machine will reduce production costs by $50,000 per year, for each year of the machine
Explanation / Answer
inorder for the firm to pay for machine
LD - LS >= 175000
25000000 - 125000000r = 2.500000 + 62500000r + 175000
r = 11.91%
for machine
Net Present Value
NPV = -175000 + 50000/1.1191 + 50000/1.1191^2 + 50000/1.1191^3 + 50000/1.1191^4 + 50000/1.1191^5 + 5000/1.1191^5
= 8489.95
Since NPV is positive, the firm should undertake the project
b)
with increse in demand interest will change
LD - LS >= 175000
25000000 - 125000000r + 3750000r= 2.500000 + 62500000r + 175000
r = 12.15%
NPV = -175000 + 50000/1.1215 + 50000/1.1215^2 + 50000/1.1215^3 + 50000/1.1215^4 + 50000/1.1215^5 + 5000/1.1215^5
= 7389.26
NPV is postive the firm should accept project
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