You are thinking about investing in a new machine for your company. The after-ta

Question

You are thinking about investing in a new machine for your company. The after-tax cash flows expected are year 1 = $10,000; year 2 = 20,000; year 3 = 30,000. You expect to incur a major overhaul expense in year 4 leading to a cash flow of -$20,000 for that year. In year 5, you expect to generate $20,000 in cash flow from operations and an additional $30,000 in cash flow upon the sale of the machine. Your required rate of return is 10%. What is the most you are willing to pay for the machine today?

Please, provide detailed calculation.

Explanation / Answer

It is the present worth of all the cash flows that needs to be paid today as the value of the machine.

R = 10%

Present worth of all cash flows = CF1/(1+R)^1 + CF2/(1+R)^2 + CF3/(1+R)^3 + CF4/(1+R)^4 + CF5/(1+R)^5 + Salvage value / (1+R)^5

Present worth of all cash flows = 10000/1.1 + 20000/1.1^2 + 30000/1.1^3 – 20000/1.1^4 + 20000/1.1^5 + 30000/1.1^5

Present worth of all cash flows = $65545.08

Thus, $65545.08 should be paid for the machine.

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