Question

Floyd Clymer is the CFO of Bonavista Mustang, a manufacturer of parts for classic automobiles. Floyd is considering the purchase of a two-ton press which will allow the firm to stamp out auto fenders. The equipment costs $250,000. The project is expected to produce after-tax cash flows of $60,000 the first year and increase by $10,000 annually; the after-tax cash flow in year 5 will reach $100,000. Liquidation of the equipment will net the firm $10,000 in cash at the end of five years, making the total cash flow in year five $110,000. Assume the required return is 15%. What is the project's net present value?

Answer 1

To calculate the project's NPV, future after-tax cash flows are discounted back to their present value using a 15% required return rate, summed, and subtracted from the initial investment cost.

Step-by-step explanation:

The question given asks about calculating the net present value (NPV) for the purchase of a press by Bonavista Mustang's CFO, Floyd Clymer. The scenario details involve an initial investment of $250,000 for the press and after-tax cash flows that start at $60,000 in the first year and increase by $10,000 each subsequent year until the fifth year, which culminates with a $100,000 cash flow plus a $10,000 liquidation value. To ascertain the NPV, we apply a 15% required return rate to discount the future cash flows back to their present value. The individual present values of these cash flows are summed and then subtracted from the initial investment to determine the NPV. Overall, this NPV calculation will aid in making an informed financial decision regarding the equipment's purchase.