Delta, Inc. is considering the investment of $75,000 in a new machine. The machi

Question

Delta, Inc. is considering the investment of $75,000 in a new machine. The machine will generate cash flow of $16,800 per year for each year of its seven-year life and will have a salvage value of $12,000 at the end of its life. Delta Inc.'s cost of capital is 14% percent. (a.) Calculate the net present value of the proposed investment. Ignore income taxes, and round all answers to the nearest $1. (b.) What will the internal rate of return on this investment be relative to the cost of capital (higher, lower, or the same)? Explain your answer.

Explanation / Answer

Year        Cashflows    Discount rate at 14%

0             (75000)             1.000

1 - 7         16800               4.288

7              12000               0.400

Net present value = -75000 + 16800 x 4.288 + 12000 x 0.40 = $1838

(b)

The internal rate of return on this investment will be higher than the cost of capital. The internal rate of return is the discount rate where NPV will be equal to zero. The higher the discount rate, the higher the return required, thus net present value will be lower.

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