Question

EE Printing is evaluating the acquisition of a new computer system with a total depreciable base of $180,000. The new equipment is expected to increase earnings before depreciation and taxes by $60,000 during years 1 to 3 and $32,000 during years 4 to 6. EE's marginal tax rate is 40%, and the cost of capital is 11%.

A. Calculate the Net Present Value (NPV) using the given information and formulas. Round your final answer to zero decimal places.

B. Calculate the Payback Period for the investment. Round your answer to two decimal places.

C. Based on the Net Present Value, is the acquisition of the equipment a good investment? True or False.

Answer 1

To calculate the Net Present Value (NPV), calculate the present value of each cash flow and subtract the initial investment. The Payback Period is the time it takes for the cash inflows to equal the initial investment. Based on the NPV, the equipment acquisition is a good investment.

Step-by-step explanation:

To calculate the Net Present Value (NPV), we need to calculate the present value of each cash flow and subtract the initial investment. First, we calculate the present value of the cash flows during years 1-3. We use the formula: PV = CF / (1 + r)^n, where CF is the cash flow, r is the discount rate, and n is the number of years. The present value of the cash flows during years 1-3 is $153,857. Next, we calculate the present value of the cash flows during years 4-6, which is $74,877.

To calculate the NPV, we subtract the initial investment from the present value of the cash flows: NPV = $153,857 + $74,877 - $180,000. The NPV is $48,734.

The Payback Period is the time it takes for the cash inflows to equal the initial investment. We can calculate the Payback Period by dividing the initial investment by the annual cash inflow. The annual cash inflow is the average of the cash flows during years 1-3 and years 4-6, which is ($60,000 + $32,000) / 2 = $46,000. The Payback Period is $180,000 / $46,000 = 3.91 years (rounded to two decimal places).

Based on the Net Present Value, the acquisition of the equipment is a good investment. The positive NPV indicates that the project is expected to generate more value than its cost and provides a return higher than the cost of capital.