Question

xercise 25-6 Net present value LO P3

A new operating system for an existing machine is expected to cost $770,000 and have a useful life of six years. The system yields an incremental after-tax income of $295,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $12,400.

A machine costs $470,000, has a $30,500 salvage value, is expected to last eight years, and will generate an after-tax income of $70,000 per year after straight-line depreciation.

Assume the company requires a 12% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1, FV of $1, PVA of $1 and FVA of $1) (Use appropriate factor(s) from the tables provided.)

A.

Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual cash flow	Future Value of 1	$420,233	x	4.3553	=	$1,830,241
Residual value		$18,600	x	0.5645	=	10,500
						$1,840,741
	Net present value

Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual cash flow					=	$0
Residual value					=	0
	Net present value

Answer 1

A.
Cash flow	Select chart	Amount	X	P.V factor @12%	=	Present Value
Annual Cash Flow	Present Value Annuity $1	$ 2,95,000	X	4.1114	=	$12,12,865
Residual Value	Present Value $1	$     12,400	X	0.5066	=	$6,282
	Total				=	$12,19,147
	Initial Investment				=	$7,70,000
	Net Present Value				=	$4,49,147
B.
Cash flow	Select chart	Amount	X	P.V factor	=	Present Value
Annual Cash Flow	Present Value Annuity $1	$     70,000	X	4.9676	=	$3,47,735
Residual Value	Present Value $1	$     30,500	X	0.4039	=	$12,318
	Total				=	$3,60,053
	Initial Investment				=	$4,70,000
	Net Present Value				=	$ -1,09,947