Figure 14-10. Present value of $1 Present value of an Annuity of $1 Problem 14-1
ID: 2605996 • Letter: F
Question
Figure 14-10.
Present value of $1
Present value of an Annuity of $1
Problem 14-12
Refer to Figure 14-10. Ray Corporation is looking to invest in a new piece of equipment. Two manufacturers of this type of equipment are being considered. After-tax inflows for the two competing projects are:
Both projects require an initial investment of $400,000. In both cases, assume that the equipment has a life of five years with no salvage value.
Required:
A. Assuming a discount rate of 8 percent, compute the net present value of each piece of equipment.
B. A third option is now available for a supplier outside of the country. The cost is also $400,000, but it will produce even cash flows over its five-year life. What must the annual cash flow be for this equipment to be selected over the other two? Assume an 8 percent discount rate.
$
Explanation / Answer
SOLUTION:
1) Fallon equipment
Year
Cash Flow
Discount factor
PV
0
-400,000
1
-400,000
1
275,000
0.926
254,650
2
225,000
0.857
192,825
3
185,000
0.794
146,890
4
140,000
0.735
102,900
5
65,000
0.681
44,265
341,530
Toller Equipment Inc.
Year
Cash Flow
Discount factor
PV
0
-400,000
1
-400,000
1
70,000
0.926
64,820
2
70,000
0.857
59,990
3
285,000
0.794
226,290
4
330,000
0.735
242,550
5
390,000
0.681
265,590
459,240
2)
CF*3.993 - $400,000 = $459,240
CF*3.993 = $859,240
CF = $215,187
Thus, in order to supply outside the country the cash should be higher than $215,187
Year
Cash Flow
Discount factor
PV
0
-400,000
1
-400,000
1
275,000
0.926
254,650
2
225,000
0.857
192,825
3
185,000
0.794
146,890
4
140,000
0.735
102,900
5
65,000
0.681
44,265
341,530
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