American Imaging products has considered the purchase of a new document imaging

Question

American Imaging products has considered the purchase of a new document imaging machine that can be used to produced professional quality promotional documents for its customers. The cost of the machine is $500,000. The company estimates that it will generate additional cash flows of $100,000 per year for the 15-year life of the machine. In addition, the company expects that the machine will have a $40,000 salvage value at the end of the asset’s useful life. The required rate of return on this investment is 15% 1. Calculate the Net Present Value of this machine. 2. Should the company purchase this imaging machine? Why?

Explanation / Answer

Cost of Machine = $500,000
Additional Cash flows = $100,000
Salvage Value = $40,000
Useful Life of Machine = 15 years
Required Rate of Return = 15%

Answer 1.

Net Present Value = -$500,000 + $100,000 * PV of an Annuity of $1 (15%, 15) + $40,000 * PV of $1 (15%, 15)
Net Present Value = -$500,000 + $100,000 * (1 - (1 / 1.15)^15) / 0.15 + $40,000 / 1.15^15
Net Present Value = -$500,000 + $100,000 * 5.84737 + $40,000 * 0.12289
Net Present Value = $89,652.60

Answer 2.

So, this machine should be purchase as its NPV is positive.

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