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NPV and maximum return: A firm can purchase new equipment for a ​$21,000 initial investment. The...

NPV and maximum return: A firm can purchase new equipment for a ​$21,000 initial investment. The equipment generates an annual​ after-tax cash inflow of $8,000 for 55 years.

a. Determine the net present value (NPV​) of the​ asset, assuming that the firm has a cost of capital of 12​%. Is the project​ acceptable?

b. Determine the maximum required rate of return that the firm can have and still accept the asset.

Please show and explain work!

Solutions

Expert Solution

Net Present Value(NPV)= Present value of cash inflows - Present value of cash outflows

The decision Criterion for Accept/Reject :

NPV>0 Accept the proposal

NPV<0 Reject the proposal

NPV=0 Accept/Reject the proposal i.e Indifferent point.

Step 1: Calculation of the present value of cash inflows

Annual cash flows after tax = $ 8000

Present value annuity factor PVAF (12%, 55 years) = 8.317 (For calculation see: Image attached)

The present value of cash inflows = Annual cash inflows after tax*PVAF (12%, 55 years)

= $ 8000*8.317

= $ 66536

Step 2: Present value of cash out flows = $ 21000

Step 3: NPV = Present value of cash inflows - Present value of cash outflows

NPV = $ 66536 - $ 21000

NPV = $ 45536

Decision: Since NPV is > 0 accept the proposal.

2. Calculation of maximum rate of return i.e, Internal rate of return (IRR)

jeff jeffy answered 9 months ago
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