Question

Bert Company was making a decision with regard to a new and improved machine for its factory. The new machine is estimated to last 5 years. The new machine will improve future cash flows in each of the 5 years. Bert’s cost of capital is 12%. Which of the following is NOT true with regard to making the decision to buy the new machine?

Question 30 options:

	Applying present value of a lump sum to 5 years of cash flows and adding them up and subtracting the cost of the machine will get Net Present Value of the machine.
	The internal rate of return for the machine needs to be at least 12% to justify the purchase.
	The cost of the new machine is used to calculate the Net Present Value.
	A decrease in the cost of capital will make Bert less likely to purchase the new machine.

Answer 1

Answer : A decrease in the cost of capital will make Bert less likely to purchase the new machine.

Reason:-

Option one is correct because to Calculate NPV we need to multiply PV factor with Cash inflow and then Subtract the cost of the machine to get NPV. If NPV is positive then we will buy new machine.

Option two is Correct because as given in question cost of capital is 12%, it means PV of all the cash flow at 12% rate, atleast must be equal to cost of capital if company wants to purchase new machine.

To calculate NPV we need to Subtract cost of capital from PV of all cash inflows.

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