Question

The following data are accumulated by Paxton Company in evaluating the purchase of $136,300 of equipment, having a four-year useful life: Net Income Net Cash Flow Year 1 $35,000 $59,000 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 12%, 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 $ b. Would management be likely to look with favor on the proposal? The net present value indicates that the return on the proposal is than the minimum desired rate of return of 12%.

Answer 1

Answer a.

Cash Flows:
Year 0 = -$136,300
Year 1 = $59,000
Year 2 = $45,000
Year 3 = $34,000
Year 4 = $23,000

Discount Rate = 12%

Present Value of Net Cash Flow = $59,000*PV of $1(12%,1) + $45,000*PV of $1(12%,2) + $34,000*PV of $1(12%,3) + $23,000*PV of $1(12%,4)
Present Value of Net Cash Flow = $59,000*0.893 + $45,000*0.797 + $34,000*0.712 + $23,000*0.636
Present Value of Net Cash Flow = $127,388

Net Present Value = Present Value of Net Cash Flow - Amount to be invested
Net Present Value = $127,388 - $136,300
Net Present Value = -$8,912

Answer b.

The net present value indicates that the return on the proposal is less than the minimum desired rate of return of 12%.