Question

Your business is considering purchasingequipment that costs $150,000and has a useful life of 5 years. At the end of 5 years the equipment will be worthless. The equipment is projected to generate cash savings of $40,888 per year over its life. The firm requires a return of 10 percent on the investment. Should they invest in this equipment

Answer 1

The company should buy the equipment since the NPV is positive.

Step-by-step explanation:

Giving the following information:

Initial investment= $150,00

Annual cash flow= $40,888

Number of periods= 5 years

Discount rate= 10%

To determine whether the company should buy or not the equipment, we need to use the net present value (NPV). If the NPV is positive, the machine increases the value of the company, therefore, it should proceed with the purchase.

NPV= -Io + ∑[Cf/(1+i)^n]

∑[Cf/(1+i)^n]= Cf / (1+i)^n

Cf1= 40,888 / 1.1= 37,170.91

Cf2= 40,888 / 1.1^2= 33,791.74

Cf3= 40,888 / 1.1^3= 30,719.76

Cf4= 40,888 / 1.1^4= 27,927.05

Cf5= 40,888 / 1.1^5= 25,388.23

∑[Cf/(1+i)^n]= $154,997.69

Now, the NPV:

NPV= -150,000 - 154,997.69

NPV= $4,997.69

The company should buy the equipment since the NPV is positive.