Question

Maylin is the financial advisor for her company and is considering the purchase of excavation equipment which will cost $58,000. The purchase of this equipment is expected to save her company $5,392 at the end of every year for 15 years. At the end of the 15 years, she expects the excavation equipment to have a residual (inflow) value of $15,400. The company requires a 6.2% rate of return.

1) What is the Net Present Value (NPV) of this equipment investment?

Answer 1

NPV is obtained by discounting the sum of annual savings and the residual inflow value at the end of the investment period by the company's required rate of return, and subtracting the cost of the equipment. The rate to discount the cash flows should be 6.2%, as per the question, not the 15% interest rate mentioned in the provided references.

Step-by-step explanation:

The Net Present Value (NPV) of an investment is calculated by subtracting the present value of outflows (initial investments) from the present value of inflows (cash flows from investment) over the period of the investment. To find the NPV of the excavation equipment, we must calculate the present value of the annual savings for 15 years at a 6.2% required rate of return and add the present value of the residual inflow value after 15 years.

It should be noted that the given reference information mentioning a 15% interest rate seems incorrect, as the question states a 6.2% rate of return.

The NPV calculation involves:

1. Calculating the present value of the annual savings by discounting each year's savings back to its present value.
2. Calculating the present value of the $15,400 residual inflow expected at the end of year 15.
3. Subtracting the initial cost of the equipment from the sum of the discounted cash flows and the discounted residual value.