Question

A manufacturing firm is deciding whether to invest in a new printer that needs an initial investment of $140,000. This will increase cash flow in the first year by $80,000 and by $75,000 in the second year. Assume the interest rate is 10%.

a. What is the net present value of these cash flows? Will the firm invest in the printer?

b. If the interest rate falls to 4%, does the firm invest in the new technology? Why or why not? Show the necessary calculations to find your answer.

c. Shouldn’t we be using marginal analysis to make this decision? Why or why not?

Answer 1

(a)

NPV ($) = - 140,000 + 80,000 x P/F(10%, 1) + 75,000 x P/F(10%, 2)

= - 140,000 + 80,000 x 0.9091 + 75,000 x 0.8264

= - 140,000 + 72,728 + 61,980

= - 5,292

Since NPV < 0, firm should not invest.

(b)

NPV ($) = - 140,000 + 80,000 x P/F(4%, 1) + 75,000 x P/F(4%, 2)

= - 140,000 + 80,000 x 0.9615 + 75,000 x 0.9246

= - 140,000 + 76,920 + 69,345

= 6,265

Since NPV > 0, firm should invest.

(c)

Since cash flows are distributed over two periods, a time-value weighted analysis should be done instead of marginal analysis.