Q1) Prince Company's required rate of return is 10%. Company is thinking of buying of three machines, as given below. Consider each machine independently.
Required:
a. Machine A will cost= $25,000 and have a life of 15 years. Its salvage value will be $1,000, and cost savings are projected at $3,500 per year. Calculate machine's net present value.
b. How much will Prince Company be eager to pay for Machine B if machine promises annual cash inflows of $5,000 per year for 8 years?
c. Machine C has projected life of 10 years. Determine machine's internal rate of return, to the nearest whole percent, if it costs $30,000 and will save $6,000 annually in cash operating costs? Would you suggest purchase? Describe.
$1,860
a
|
|
Year
|
Amount
|
10% Factor
|
Present Value
|
| |
Investment required
|
now
|
($25,000)
|
1
|
($25,000)
|
| |
Annual cost savings
|
1-15
|
$3,500
|
7.606
|
26,621
|
| |
Salvage value
|
15
|
$1,000
|
0.239
|
239
|
| |
Net present value
|
|
|
|
$1,860 |
b
|
|
Year
|
Amount
|
10% Factor
|
Present Value
|
| |
Annual cash inflows
|
1-8
|
$5,000
|
5.335
|
$26,675
|
As present value of cash inflows is $26,675, company should be eager to pay up to this amount to acquire machine.
c. Investment required + Net annual cash flow = Factor of internal rate of return
$30,000 + $6,000 = 5.000
To nearest whole percent, internal rate of return is 15%.
Machine should be bought, as internal rate of return is greater than required rate of return.