The Pan American Bottling Co. is considering the purchase of a new machine that

Question

The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $72,000. The annual cash flows have the following projections. Use Appendix B http://lectures.mhhe.com/connect/0077861612/appendix_b.jpg and Appendix D http://lectures.mhhe.com/connect/0077861612/appendix_d.jpg for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Year Cash Flow

1 $ 35,000

2 $38,000

3 $35,000

4 $28,000

5 $12,000

a. If the cost of capital is 12 percent, what is the net present value of selecting a new machine? (Do not round intermediate calculations and round your final answer to 2 decimal places.) Net present value $

b. What is the internal rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Internal rate of return %

c. Should the project be accepted? Yes No

Explanation / Answer

a)Year Cash Flow *12%PVIF    present value

1 $ 35,000 0.893 $31255

2 $38,000 0.797 $30286

3 $35,000 0.712 $24920

4 $28,000 0.636 $17808

5 $12,000 0.567 $6804

present value inflows=$111073

present value outflows=$72000

net present value =$39073

b) internal rate of return

Cash Flow

$ 35,000

$38,000

$35,000

$28,000

$12,000

average to get assumed annunity=148000/5=29600

we divide the investment by assumed annunity value=72000/29600=2.43

using appendix d for n=5,we will try 35%

Year Cash Flow *35%PVIF    present value

1 $ 35,000 0.741 $25935

2 $38,000 0.549 $20862

3 $35,000 0.406 $14210

4 $28,000 0.301 $8428

5 $12,000 0.223 $2676

present value of inflows= $72111

since 35%is not sufficient try highest rate 40%

Year cash Flow *40%PVIF    present value

1 $ 35,000 0.714 $24990

2 $38,000 0.510 $19380

3 $35,000 0.364 $12600

4 $28,000 0.260 $7280

5 $12,000 0.186 $2232

present value of inflows= $66482

the correct answer must fall between 35% and 40%

$72111@35% $72111@35%

$66482@40% $72000 cost

=$5629 =$111

internal rate of return=35%+($111/$5629) *5%=35%+0.098%=35.10%

c)the project should be accepted because the net present value is positive and internal rate of return exceeds the cost of capital

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