Question

A factory costs $696,670. You forecast that it will produce cash inflows of $314,053 in year 1,$175,000 in year 2 , and $230,000 in year 3 . The discount rate is 10.50%.

a. Calculate the PV of cash inflows. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
b. Should the company invest in the factor?

Answer 1

The present value of cash inflows from the factory using a discount rate of 10.50% is $597,971.21. Since this is less than the cost of the factory ($696,670), it would not be advisable to invest in the factory based on these calculations.

Step-by-step explanation:

To calculate the present value (PV) of cash inflows, we discount future cash flows back to the present using the given discount rate of 10.50%. The formula to calculate the present value of a cash flow is: PV = Cash Flow / (1 + r)n, where 'r' is the discount rate and 'n' is the number of years until the cash flow.

Now, let's calculate the PV for each year:

1. Year 1: PV = $314,053 / (1 + 0.1050)1 = $314,053 / 1.1050 = $284,126.24
2. Year 2: PV = $175,000 / (1 + 0.1050)2 = $175,000 / 1.2210 = $143,316.30
3. Year 3: PV = $230,000 / (1 + 0.1050)3 = $230,000 / 1.3493 = $170,528.67

The total PV of cash inflows is therefore $284,126.24 + $143,316.30 + $170,528.67 = $597,971.21.

As the PV of cash inflows ($597,971.21) is less than the cost of the factory ($696,670), the factory is not a good investment based on these figures alone.