Question

The management team at Stanton Corporation is evaluating two alternative capital investment opportunities. The first alternative, modernizing the company’s current machinery, costs $45,000. Management estimates the modernization project will reduce annual net cash outflows by $12,500 per year for the next five years. The second alternative, purchasing a new machine, costs $56,500. The new machine is expected to have a five-year useful life and a $4,000 salvage value. Management estimates the new machine will generate cash inflows of $15,000 per year. Stanton’s cost of capital is 10 percent.

Required

a.     Determine the present value of the cash flow savings expected from the modernization program.

b.     Determine the net present value of the modernization project.

c.     Determine the net present value of investing in the new machine.

d.    Use a present value index to determine which investment alternative will yield the higher rate of return.

Answer 1