Exercise 13-2 Net Present Value Method [LO13-2] The management of Kunkel Company

Question

Exercise 13-2 Net Present Value Method [LO13-2] The management of Kunkel Company is considering the purchase of a $27,000 machine that would reduce operating costs by $7,000 per year. At the end of the machine's five-year useful life, it will have zero scrap value. The company's required rate of return is 12%. Click here to view Exhibit 138-1 and Exhibit 13B-2, to determine the appropriate discount factorfs) using table. Required 1. Determine the net present value of the investment in the machine. Net present value 2. What is the difference between the total, undiscounted cash inflows and cash outfiows over the entire life of the machine? (Any cash outflows should be indicated by a minus sign.) Total Cash Flows Item Cash Flow Years Annual cost savings Initial investment Net cash flow

Explanation / Answer

1. Now 1 2 3 4 5

Purchase of machine $(27,000)

Reduced operating costs $7,000 $7,000 $7,000 $7,000 $7,000

Total cash flows $(27,000) $7,000 $7,000 $7,000 $7,000 $7,000

Discount factor(12%) 1.0000 0.893 0.797 0.712 0.636 0.567

Present value $(27,000) $6,251 $5,579 $4,984 $4,452 $3,969

Net Present Value $(1,765)

2. Item Cash Flow Years Total Cash Flows

Annual cost savings $ 7,000 5 $ 35,000

Initial investment $ (27,000) 1 $ (27,000)

Net cash flow $ 8,000   

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