Question

Net Present Value Method

The following data are accumulated by Geddes Company in evaluating the purchase of $123,300 of equipment, having a four-year useful life:

	Net Income		Net Cash Flow
Year 1	$34,000		$58,000
Year 2	21,000		45,000
Year 3	10,000		34,000
Year 4	(1,000)		23,000

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

a. Assuming that the desired rate of return is 10%, determine the net present value for the proposal. Use the table of the present value of $1 presented above. If required, round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

Present value of net cash flow	$
Amount to be invested
Net present value	$

Answer 1

Present value of cash inflows

Year	Cash inflows	Present value factor at 10% discounting rate	Present value of cash inflows
1	$ 58000	0.909	$ 52722
2	$ 45000	0.826	$ 37170
3	$ 34000	0.751	$ 25534
4	$ 23000	0.683	$ 15709
Present value of cash inflows	$ 131135

Desired rate of return is 10%, so it will used as the discounting rate.

Present value of cash inflow = Cash inflow * Discounting factor

The present value of the cash outflow of $ 123300 occurring in the year zero will be same as that amount, because the present value factor will be one.

Net present value of the proposal

= Present value of cash inflows – Present value of cash outflows (amount to be- invested)

= $ 131135 - $ 123300 = $ 7835