Magic Corporation, an amusement park, is considering a capital investment in a n

Question

Magic Corporation, an amusement park, is considering a capital investment in a new exhibit. The exhibit would cost $203,367 and have an estimated useful life of 10 years. It will be sold for $66,200 at that time. (Amusement parks need to rotate exhibits to keep people interested.) It is expected to increase net annual cash flows by $29,300. The company’s borrowing rate is 8%. Its cost of capital is 10%.

TABLE 1 Future Value of 1 Periods 4% 5% 6% 170 790 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.04000 1.05000 1.06000 1.07000 1.08000 1.09000 1.10000 1.11000 .12000 1.15000 1.08160 1.10250 .12360 1.14490 1.16640 1.18810 1.21000 1.23210 1.25440 .32250 1.12486 .15763 1.19102 1.22504 1.25971 1.29503 .33100 1.36763 1.40493 1.52088 1.16986 1.21551 1.26248 1.31080 1.36049 1.41158 1.46410 1.51807 1.57352 1.74901 1.21665 1.27628 1.33823 1.40255 1.46933 1.53862 1.61051 1.68506 1.76234 2.01136 1.26532 1.34010 1.41852 1.50073 1.58687 1.67710 1.77156 1.87041 1.97382 2.31306 1.31593 1.40710 1.50363 1.60578 1.71382 1.82804 1.94872 2.07616 2.21068 2.66002 1.368571.47746 1.59385 1.71819 1.85093 1.99256 2.14359 2.30454 2.47596 3.05902 1.42331 .55133 1.68948 1.83846 1.99900 2.17189 2.35795 2.55803 2.77308 3.51788 1.48024 1.62889 1.79085 1.96715 2.15892 2.36736 2.59374 2.83942 3.10585 4.04556 1.539451.71034 1.89830 2.10485 2.33164 2.58043 2.85312 3.15176 3.47855 4.65239 1.60103 1.79586 2.01220 2.25219 2.51817 2.81267 3.13843 3.49845 3.89598 5.35025 1.665071.88565 2.13293 2.40985 2.71962 3.0658 3.45227 3.88328 4.36349 6.15279 1.73168 1.97993 2.26090 2.57853 2.93719 3.34173 3.79750 4.31044 4.88711 7.07571 1.800942.07893 2.39656 2.75903 3.17217 3.64248 4.17725 4.78459 5.47357 8.13706 1.87298 2.18287 2.54035 2.95216 3.42594 3.97031 4.59497 5.31089 6.13039 9.35762 1.94790 2.29202 2.69277 3.15882 3.70002 4.32763 5.05447 5.89509 6.86604 10.76126 18 2.02582 2.40662 2.85434 3.37993 3.99602 4.71712 5.55992 6.54355 7.68997 12.37545 19 2.10685 2.52695 3.02560 3.61653 4.31570 5.14166 6.11591 7.26334 8.61276 14.23177 2.19112 2.65330 3.20714 3.86968 4.66096 5.60441 6.72750 8.06231 9.64629 16.36654 2 10 12 13 14 15 16 17 20

Explanation / Answer

Annual cash flows = $29,300

Present value of annuity of 1 @ 10% for 10 years = 6.14457

Present value of annual cash flows = $29,300 * 6.14457 = $180,035.90

Sale value of exhibit at the end of 10 years = $66,200

Present value of 1 @ 10% for 10 years = 0.38554

Present value of sale value of exhibit = $66,200 * 0.38554 = $25,522.75

Net present value = -Cost of exhibit + Present value of annual cash flows + Present value of sale value of exhibit = -$203,367 + $180,035.90 + $25,522.75 = $2,191.65

The project is acceptable because net present value is positive.

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