(Ignore income taxes in this problem.) Dunken, Inc., is considering the purchase
ID: 2482355 • Letter: #
Question
(Ignore income taxes in this problem.) Dunken, Inc., is considering the purchase of a machine that would cost $110,000 and would last for 4 years. At the end of 4 years, the machine would have a salvage value of $18,000. The machine would reduce labor and other costs by $35,000 per year. Additional working capital of $5,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 8% on all investment projects. The net present value of the proposed project is closest to:
Explanation / Answer
Calculation of Net Present Value of of Invetment decision Dunken, Inc Year Cash outflow Net Cashinflows(increase in Revenue) Discount Factor (@8%) Discounted Cashflow 0 $ -1,15,000 1.00 $ -1,15,000 1 $ 35,000 0.93 $ 32,407 2 $ 35,000 0.86 $ 30,007 3 $ 35,000 0.79 $ 27,784 4 $ 58,000 0.74 $ 42,632 Total Net Present Value $ 17,830 Working Note: Calculation of Net Cashinflows Year Revenue Increases (A) working capital recovery Salvage value (C,) Net Cashinflows (A)-(B)+ (.C) 1 $ 35,000 $ - $ 35,000 2 $ 35,000 $ - $ 35,000 3 $ 35,000 $ - $ 35,000 4 $ 35,000 $ 5,000 $ 18,000 $ 58,000 Conclusion: By Investing in the new machine, Dunken, Inc can earn a Net Present Value of $ 17,830 over the four years time period, i.e at the end of expected useful life of the equipment. The Net Present Value means the excess of present value of cash inlows during the useful life of the equipment including the salvage value over the cost of equipment incurred at present. Considering the Net Present Value alone Dunken , Inccan buy the machine provided the expected cash flows materialises.
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