Question

The management of Kunkel Company is considering the purchase of a $29,000 machine that would reduce operating costs by $6,500 per year. At the end of the machine’s five-year useful life, it will have zero salvage value. The company’s required rate of return is 16%.

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.

Required:

1. Determine the net present value of the investment in the machine.

2. What is the difference between the total, undiscounted cash inflows and cash outflows over the entire life of the machine?

Answer 1

1
	Now	1	2	3	4	5
Purchase of machine	-29000
Reduced operating costs		6500	6500	6500	6500	6500
Total cash flows	-29000	6500	6500	6500	6500	6500
Discount factor (16%)	1	0.862	0.743	0.641	0.552	0.476
Present value	-29000	5603	4830	4167	3588	3094
Net present value	-7719
2
	Cash Flow	Years	Total Cash Flows
Annual cost savings	6500	5	32500
Initial investment	-29000	1	-29000
Net cash flow			3500
Total difference in undiscounted cash inflows and cash outflows = $3500