Question

Eastside Farms is considering the purchase of a mechanical harvester. It costs $180,000 and is expected to last for five years. They presently hire 10 workers at $3,000 per month for each of the six harvesting months each year. The equipment would eliminate the need for 3 workers. Eastside projects a salvage value of $23,000. Ignoring the tax implications and assuming the opportunity cost of funds is 8.0%, what is the Net Present Value (NPV) of this proposed investment?

Answer 1

Answer)

Calculation of Net Present Value

Net Present value = Present value of cash inflows – Present value of cash outflows

                                  = $ 231,260 - $ 180,000

                                 = $ 51,260

Therefore the Net Present value of the proposed investment is $ 51,260.

Working Note:

Calculation of Annual cash inflows

Annual Cash inflow will be equal to the 6 months’ Salary of 3 workers

Annual cash inflow = Monthly wages X 6 Months X 3 workers

                                    = $ 3,000 per months X 6 Months X 3 workers

                                   = $ 54,000

Therefore the annual cash inflow will be $ 54,000

Calculation of Present value of cash inflows:

Present value of cash inflows = (Annual cash inflows X Present value annuity factor at 8% for 5 years) + (salvage value of machine X Present value factor at 8% for 5 years)

                                                      = ($ 54,000 X 3.99271) + ($ 23,000 X 0.68058)

                                                       = $ 215,606.34 + 15,653.34

                                                       = $ 231,260 (rounded off)

Calculation of Present value of cash Outflows:

Since the investment in machine is made today, the present value of cash outflow will be equal to the initial cash outflow, i.e. $ 180,000