The Dohickie Company is considering an investment in equipment. The following in

Question

The Dohickie Company is considering an investment in equipment. The following information is available: Cost $300,000 ($200,000 down, $50,000 end of first year and starting at the end of the fourth year, $10,000 per year until completely paid) Economic life -10 years Annual Profit from Investment Years 1-5 $50,000/peryear Years 6-10 $30,000/per year Salvage Value $1,000 Repair Required at End of Year 8 - $2,000 No Need for Old Machine if Purchasing New One. Cost $300,000 Accum. Depreciation $280,000 Sales Price $25,000 Gain on Sale $5,000 Required Rate of Return 8% REQUIRED: 1) Using Net Present Value Method, show calculations to determine if investment should be made. 2) What is the Payback Period?

Explanation / Answer

Answer 1 Calculation of present value of Cash flow Year Cash outflow for new machine Cash Inflow Annual Profit Salvage value of new machine Repair Sale of old machine Net Cash flow PV factor @ 8% Present value of cash flow 0 -$2,00,000.00 $25,000.00 -$1,75,000.00 $1.00 -$1,75,000.00 1 -$50,000.00 $50,000.00 $0.00 $0.93 $0.00 2 $50,000.00 $50,000.00 $0.86 $42,866.94 3 $50,000.00 $50,000.00 $0.79 $39,691.61 4 -$10,000.00 $50,000.00 $40,000.00 $0.74 $29,401.19 5 -$10,000.00 $50,000.00 $40,000.00 $0.68 $27,223.33 6 -$10,000.00 $30,000.00 $20,000.00 $0.63 $12,603.39 7 -$10,000.00 $30,000.00 $20,000.00 $0.58 $11,669.81 8 -$10,000.00 $30,000.00 -$2,000.00 $18,000.00 $0.54 $9,724.84 9 $30,000.00 $30,000.00 $0.50 $15,007.47 10 $30,000.00 $1,000.00 $31,000.00 $0.46 $14,359.00 Net Present Value $27,547.58 As net present value of investment is positive , the investment should be made. Answer 2 In the eight year company recovers total $173181 cost of investment Balance of $1819 , it recovers in 9 th year. hence payback period = 8 years + $1819 / $15007.47 = 8 years + 0.12 years = 8.12 years.

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