Question

Connor Company is considering the purchase of new equipment for $125,000. The expected life of the...

Connor Company is considering the purchase of new equipment for $125,000. The expected life of the equipment is 5 years with no residual value. The equipment is expected to earn revenues of $155,000 per year. Total expenses, including depreciation, are expected to be $125,000 per year. Connor management has set a minimum acceptable rate of return of 15%. Assume straight-line depreciation.

a. Determine the equal annual net cash flows from operating the equipment. Round to the nearest dollar.
$

Present Value of an Annuity of $1 at Compound Interest
Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 1.833 1.736 1.690 1.626 1.528
3 2.673 2.487 2.402 2.283 2.106
4 3.465 3.170 3.037 2.855 2.589
5 4.212 3.791 3.605 3.352 2.991
6 4.917 4.355 4.111 3.784 3.326
7 5.582 4.868 4.564 4.160 3.605
8 6.210 5.335 4.968 4.487 3.837
9 6.802 5.759 5.328 4.772 4.031
10 7.360 6.145 5.650 5.019 4.192

b. Calculate the net present value of the new equipment using the present value of an annuity of $1 table above. Round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

Annual net cash flow $
Present value of equipment cash flows $
Less equipment costs $
Net present value of equipment $

Homework Answers

Answer #1

(a): Equal annual net cash flows = Revenues – Total expenses

Now total expenses will have to be adjusted for depreciation. Depreciation per year = 125,000/5 = $25,000 per year.

Thus expenses without depreciation = annual expenses - depreciation = 125,000-25,000 = $100,000

Equal annual net cash flows = 155,000 -100,000

= $55,000

b. Present value of equipment cash flows = 55,000*Present value of annuity for 5 years and 15%

= 55,000*3.352

= $184,360

Thus net present value = present value of annual cash flows - investment

= $184,360 - 125,000

= $59,360

Annual net cash flow $ 55,000.00
Present value of equipment cash flows $ 184,360.00
Less: equipment costs $ 125,000.00
Net present value of the equipment $ 59,360.00
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