Question

Modella Construction Company is considering buying a new piece of equipment to use in their business: Cost of equipment……………………………………….. $10,000 Annual net cash inflows…………………………………. $2,800 Working Capital required…………………………..……. $5,000 Salvage value of equipment ………………….…………. $1,000 Life of the equipment …………………………….……… 8 years Discount rate ……………………………………………… 10% At the completion of 8 years, the working capital will be released for use elsewhere. Compute the net present value of the equipment, and state if they should buy the equipment or not. Show all work.

Answer 1

Solution:

Computation of NPV - Modella Construction Company
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Cost of Equipment	$10,000.00	0	1	$10,000.00
Working capital investment	$5,000.00	0	1	$5,000.00
Present Value of Cash Outflows (A)				$15,000.00
Cash Inflows:
Annual cash inflows	$2,800.00	1-8	5.334926	$14,937.79
Salvage Value	$1,000.00	8	0.466507	$466.51
Release of working capital	$5,000.00	8	0.466507	$2,332.54
Present Value of Cash Inflows (B)				$17,736.84
Net Present Value (B-A)				$2,736.84

As NPV is positive, therefore equipment should be purchased.