Question

Revive Beverage Company (RBC) is considering buying new bottling equipment for its factories. It will take one year to order and install the equipment. The second year they will gain 2 million in revenues. The third year they will gain 3 million in revenues. At the start of the fourth year they will scrap the equipment and a salvage company will haul it away for free but with no payment to RBC. At which of the following prices and interest rates would RBC find the equipment profitable?

Answer 1

RBC should compare the present value of projected revenues with the cost of bottling equipment at a 4% discount rate to determine profitability. Equipment is profitable if the cost is less than the sum of discounted revenues. A cost of $183 million exceeds this sum, indicating it is not a profitable investment.

Step-by-step explanation:

The Revive Beverage Company (RBC) is assessing the profitability of new bottling equipment based on future projected revenues and current costs, taking into account the time value of money with an interest rate consideration. To calculate profitability, RBC would need to compare the present value of future cash flows from the equipment against its purchasing cost. If the firm assumes an effective rate of return of 4%, it would consider investing if the cost of the equipment is less than or equal to the present value of $2 million in Year 2 plus $3 million in Year 3, discounted back at the 4% rate over the respective number of years

The salvage value at the start of Year 4 has no monetary benefit but has social and environmental benefits due to the reduction of garbage output as hinted at by the example of the Junkbuyers Company. Therefore, the equipment would be profitable for RBC if the purchase price is less than the sum of the discounted cash flows generated by the equipment. If the equipment cost is $183 million as mentioned, it would be too high compared to the discounted revenues, and thus, not a profitable investment.