Question

Net present value LO P3

A new operating system for an existing machine is expected to cost $820,000 and have a useful life of six years. The system yields an incremental after-tax income of $240,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $100,000.
A machine costs $560,000, has a $56,000 salvage value, is expected to last eight years, and will generate an after-tax income of $150,000 per year after straight-line depreciation.
Assume the company requires a 12% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)
a. A new operating system for an existing machine is expected to cost $820,000 and have a useful life of six years. The system yields an incremental after-tax income of $240,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $100,000. (Round your answers to the nearest whole dollar.)
b. A machine costs $560,000, has a $56,000 salvage value, is expected to last eight years, and will generate an after-tax income of $150,000 per year after straight-line depreciation. (Round your answers to the nearest whole dollar.)

Answer 1

a. initial outlay = -$820,000

net cash flows years 1 - 5 = $240,000

net cash flow year 6 = $340,000

discount rate = 12%

using a financial calculator:

NPV = $217,400.87

IRR = 20.55%

b. initial outlay = -$560,000

net cash flows years 1 - 7 = $150,000

net cash flow year 8 = $206,000

discount rate = 12%

using a financial calculator:

NPV = $207,763.43

IRR = 21.65%