Sean darin, owne of Darin Rental company, LLC, want to buy some new jet skis for

Question

Sean darin, owne of Darin Rental company, LLC, want to buy some new jet skis for his rapidly expanding business. Grahams Aquatics Distribution, LLC, offers to sell Darin the jetskis for $50,000 total. Darin predicts that by adding these new asset to his fleet, the annual operating cash flow will increase by $12,000 in the first year, and due to wear and tear on the machine, will decrease thereafter by 15% per year for the next four years. Darin`s weighted average cost of capital is 11% A) what is the net present value of this investment? B) should Darin buy them? why? C) what is the discount rate that would result in a positive NPV?

Explanation / Answer

Hi, Please find the answer as follows: Part A: Cash Inflows: Year 1: 12000 Year 2 to Year 5 = 12000*(1-.15) = 10200 NPV = -50000 + 12000/(1+.11)^1 + 10200/(1+.11)^2 + 10200/(1+.11)^3 + 10200/(1+.11)^4 + 10200/(1+.11)^5 = -10680.2288 or -10680.23 Part B: No, since NPV is negative, darin should not buy the asset. Part C: A discount rate that would result in NPV = 0 will result in a + NPV. You can calculate IRR in the given case by putting the value of NPV as 0. Thanks, Aman

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