Question

Net Present Value Method

The management of Minces Company, a wholesale distributor of cracker products, is considering the purchase of a $30,000 machine that would reduce operating costs in its warehouse by $5,000 per year. At the end of the machine's eight-year useful life, it will have no scrap value. The company’s required rate of return is 11%.

Required:

(Ignore income taxes.)

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

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

Answer 1

Answer 1.

Initial Cash Outflow = $30,000
Annual Cash Inflow = $5,000
Useful Life = 8 years
Rate of Return = 11%

Present Value of Cash Inflows = $5,000 * PVA of $1 (11%, 8)
Present Value of Cash Inflows = $5,000 * (1 - (1/1.11)^8) / 0.11
Present Value of Cash Inflows = $5,000 * 5.1461
Present Value of Cash Inflows = $25,730.50

Net Present Value = Present Value of Cash Inflows - Initial Cash Outflow
Net Present Value = $25,730.50 - $30,000
Net Present Value = -$4,269.50

Answer 2

Total Cash Inflows = 8 * $5,000
Total Cash Inflows = $40,000

Difference = $40,000 - $30,000
Difference = $10,000