A firm is considering purchasing equipment that will reduce costs by ₱40,000. The equipment costs ₱300,000 and has a salvage value of ₱50,000 and a life of 7 years. The annual maintenance cost is ₱6,000. While not in use by the firm, the equipment can be rented to others to generate an income of ₱10,000 per year. If money can be invested for an 8% return, is the firm justified in buying the equipment?
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
1.Cost of the equipment | -300000 | |||||||
2.Reduction in annual costs | 40000 | 40000 | 40000 | 40000 | 40000 | 40000 | 40000 | |
3. Annual Maintenance costs | -6000 | -6000 | -6000 | -6000 | -6000 | -6000 | -6000 | |
4. Annual rental income lost, if in use | -10000 | -10000 | -10000 | -10000 | -10000 | -10000 | -10000 | |
5.Salvage at end yr. 7 | 50000 | |||||||
6.Total annual cashflows(sum 1 to 5) | -300000 | 24000 | 24000 | 24000 | 24000 | 24000 | 24000 | 74000 |
7.PV F at 8%(1/1.08^yr.n) | 1 | 0.92593 | 0.85734 | 0.79383 | 0.73503 | 0.68058 | 0.63017 | 0.58349 |
8.PV at 8%(6*7) | -300000 | 22222.22 | 20576.13 | 19051.97 | 17640.72 | 16334 | 15124.07 | 43178.29 |
NPV at 8%(Sum of row 8) | -145873 |
Answer: |
NO. Not justified in buying |
as the NPV of its predicted cashflows is NEGATIVE at the required rate of return of 8% |
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