The OC Farm is considering purchasing a used combine to harvests grain crops and
ID: 2486521 • Letter: T
Question
The OC Farm is considering purchasing a used combine to harvests grain crops and to do some custom farming. The following provides information on the used combine:
Cost
$105,000
Estimated residual value
$60,842
Estimated annual cash inflow
$47,800
Estimated annual cash outflow
$38,700
Estimated useful life (in years)
6
Required rate of return
5%
At the end of the useful life, the combine will be sold for the residual value.
What is the estimated annual net cash flow?
$2,500
$9,100
$38,700
$47,800
What is the net present value?
Negative $13,410.83
Positive $13,410.83
Do not have enough information.
None of the above
What is the IRR of the investment?
1.5%
2.0%
2.8%
None of the above
Should the OC Farm purchase the combine?
Yes!
No!
Maybe!
None of the above are correct
a.Negative $13,410.83
b.Positive $13,410.83
c.Do not have enough information.
d.None of the above
Explanation / Answer
the estimated annual net cash flow
= Estimated annual cash inflow - Estimated annual cash outflow = $47800-$38700 = $9100
net present value
= PV of net cash inflow + PV of salvage value - initial investment
= $9100 x PVIFA(5%, 6) + $60842 x PVIA(5%, 6) - $105000
= $9100 x 5.076 + $60842 x 0.746 - $105000
= -$13420.3
Answer: Negative $13410.83 (the difference is due to approximation of the discount factors)
Calculation of IRR
IRR is the discount rate at which NPV is zero
NPV at 1% = $9100*5.795+60842*0.942-105000 = $5047.7
By Interpolation we get
R = 5% + (-4% )* ((0+13420.3)/(5047.7+13420.3)) = 2%
The combine should not be ppurchased as the NPV is negative and the IRR is less than the required return.
Rate NPV 5% -13420.3 R 0 1% 5047.7Related Questions
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