EXERCISE13-1 Net Present Value Method The management of Kunkel Company is consid

Question

EXERCISE13-1 Net Present Value Method

The management of Kunkel Company is considering the purchase of a $40,000 machine that would reduce operating costs by $7,000 per year. At the end of the machine's eight-year useful life, it will have zero scrap value. The company's required rate of return is 12%.
Required:
(Ignore income taxes.)
1. Determine the net present value of the investment in the machine.
2. What is the difference between the total, undiscounted cash inflows and cash outflows over the entire
life of the machine?

Explanation / Answer

1. NPV = CF0+PVoA of PMT=$7000 for n=8Yrs at i=12% PVoA = PMT [(1 - (1 / (1 + i)^n)) / i] Where: PVoA = Present Value of an Ordinary Annuity PMT = Amount of each payment i = Discount Rate Per Period n = Number of Periods ie PVoA = 7000*[(1 - (1/(1+12%)^8))/12%] ie PVoA = 7000*{(1 - 0.4039)/12%} = 34773.50 So NPV = -40000+34773.50 = -5226.50...................Ans (1) 2. Undiscounted CFs (Inflows) are $7000 for 8 yrs = 7000*8 = $56000 Cash Outflow is $40000 So difference is Cash Inflow & Cash outflow is -40000+56000 = $16000 ......Ans (2)

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