Question

Skytop Co., a nonprofit entity, is considering acquiring a machine for $80,000 that will produce uniform cash inflows of $25,000 for four years. Skytop evaluates capital projects using discounted

cash flows at a cost of capital of 10% per year. Based upon the following table, what action should Skytop take regarding acquisition of the machine, and why?

Future value of $1 for 4 years at 10% ----------------------------$1.464
Present value of $1 for 4 years at 10% --------------------------$0.683
Future value of $1 ordinary annuity for 4 years at 10% ---------$4.641
Present value of $1 ordinary annuity for 4 years at 10% --------$3.170

Acquire: ----Reason:
A.Yes ------- Net cash flow is $20,000
B.Yes --------Net future value is $36,025
C.No --------Net present value is ($750)
D.No --------Net present value is ($8,750)

Answer 1

Skytop Co. should not acquire the machine because the NPV calculation results in a negative $750, which means the investment would not yield the minimum required return.

Step-by-step explanation:

To determine whether Skytop Co. should acquire the machine, we must calculate the net present value (NPV). The machine costs $80,000 and provides uniform cash inflows of $25,000 for four years. To find the NPV, we multiply the annual cash inflows by the present value of $1 ordinary annuity for 4 years at 10%, which is $3.170, and then subtract the initial investment.

NPV = ($25,000 × 3.170) - $80,000
NPV = $79,250 - $80,000
NPV = -$750

Since the NPV is negative, option C is correct: Skytop Co. should not acquire the machine because the net present value is ($750), indicating the project does not meet the minimum return at the cost of capital.