Exercise D9-7 Metro Industries is considering the purchase of new equipment cost

Question

Exercise D9-7 Metro Industries is considering the purchase of new equipment costing $1,200,000 to replace existing equipment that will be sold for $180,000. The new equipment is expected to have a $200,000 salvage value at the end of its 4-year life. During the period of its use, the equipment will allow the company to produce and sell an additional 30,000 units annually at a sales price of $20 per unit. Those units will have a variable cost of $12 per unit. The company will also incur an additional $90,000 in annual fixed costs. (a) Calculate the net present value of the proposed equipment purchase. Assume that Metro uses a 12% discount rate. (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to 0 decimal place, e.g. 58,971. Enter negative amount using a negative sign preceding the number for e.g.-59,992 or parentheses e.g. (59,992)) Net present value s (b) Do you recommend that Metro Industries invest in the new equipment?

Explanation / Answer

Calculate net present value :

Cash flow (1-4) = (20-12*30000-90000)*4 = 600000

Salvage (4) = 200000

Cash outflow year 0 = (1200000-180000) = 1020000

Net present value = Present value of cash inflow-Present value of cash outflow

= (600000*3.03735+200000*0.63552)-1020000

Net present value = 929514

b) Yes, Metro industries invest in the new equipment.

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