Question

Exercise 13-2 Net Present Value Analysis [LO13-2]

The management of Kunkel Company is considering the purchase of a $26,000 machine that would reduce operating costs by $6,500 per year. At the end of the machine’s five-year useful life, it will have zero salvage value. The company’s required rate of return is 16%.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using table.

Required:

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

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

Answer 1

1. Calculation of NPV.

NPV = Present Value of Cash Inflows - Present Value of Cash outflows.

Present Value of Cash outflows = $26,000

Present Value of Cash Inflows

Time	Amount	Discounted rate (1 / 1.16n)	Present Value
1	6,500	1/1.161 = 0.862	6,500 x 0.862 = 5,603
2	6,500	1/1.162 = 0.743	6,500 x 0.743 = 4829.5
3	6,500	1/1.163 = 0.641	6,500 x 0.641 = 4166.5
4	6,500	1/1.164 = 0.552	6,500 x 0.552 = 3,588
5	6,500	1/1.165 = 0.476	6,500 x 0.476 = 3,094
Total			21,281

Net Present Value = 21281 - 26,000 = (4,719)

NOTE: Depreciation is considered only for tax savings purpose and therefore is not considered in calculation

2. Undiscounted Cash Inflows = 6,500 x 5 = 32,500

Cash Outflow = 26,000

Difference = 32,500 - 26,000 = 6,500