Question

Carper Company is considering a capital investment of $390,000 in additional productive facilities. The new machinery is expected to have useful life of 6 years with no salvage value. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $20,000 and $85,000, respectively. Carper has an 8% cost of capital rate, which is the required rate of return on the investment.

Instructions (Round to two decimals.)
(a) Compute the cash payback period.
(b) Using the discounted cash flow technique, compute the net present value.
(c) Carper was presented with a second capital investment that provided similar production facilities as the first one. This investment cost $400,000, had a useful life of 7 years with a salvage value of $15,000. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $25,000 and $80,000 respectively. Carper’s 8% cost of capital is also the required rate of return on the investment.
(1) Compute the cash payback period.
(2) Using the discounted cash flow technique, compute the net present value.
(3) Based on these calculations, which investment do you recommend? Explain why.

Answer 1

a. 4.59 years

b. $2,944.77

c

1. 5 years

2. $25,261.96

3.I would recommend the second investment because the NPV for the second project is greater than that of the first project. It means that the second project is more profitable than the first project.

Step-by-step explanation:

Payback calculates the amount of time it takes to recover the amount invested in a project from it cumulative cash flows

Payback period = Amount invested / cash flow

$390,000 / $85,000 = 4.59 years

Net present value is the present value of after tax cash flows from an investment less the amount invested.

NPV can be calculated using a financial calculator

Cash flow in year 0 = $390,000

Cash flow each year from year 1 to 6 = $85,000

I = 8%

NPV = $2,944.77

For the second investment

Payback period = Amount invested / cash flow

$400,000 / $80,000 = 5 years

Cash flow in year 0 = -$400,000

Cash flow each year from year 1 to 6 = $80,000

Cash flow in year 7 = $80,000 + $15,000 = $95,000

I = 8%

NPV = $25,261.96

I would recommend the second investment because the NPV for the second project is greater than that of the first project. It means that the second project is more profitable than the first project.

To find the NPV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute