Question

You have just been offered a contract worth

$1.18

million per year for

7

years.​ However, to take the​ contract, you will need to purchase some new equipment. Your discount rate for this project is

12.5%.

You are still negotiating the purchase price of the equipment. What is the most you can pay for the equipment and still have a positive

NPV​?

Answer 1

The amount is computed as shown below:

Present value = Future value / (1 + r)ⁿ

= $ 1.18 million / 1.125¹ + $ 1.18 million / 1.125² + $ 1.18 million / 1.125³ + $ 1.18 million / 1.125⁴ + $ 1.18 million / 1.125⁵ + $ 1.18 million / 1.125⁶ + $ 1.18 million / 1.125⁷

= $ 5.30 million Approximately

If the benefits from the contract will be $ 5.30 million, the NPV from the equipment will be 0.

So, any cost below $ 5.30 million will give us a positive NPV.

In approximate terms, we can say the most that we shall pay for the equipment shall be $ 5.29 million.

Please ask in case of any query.