Question

1.

Your company is deciding whether to invest in a new machine. The new machine will increase cash flow by $333,520 per year. You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will be obsolete 10 years from today. The machine is currently priced at $1,760,000. The cost of the machine will decline by $110,000 per year until it reaches $1,320,000, where it will remain. The required return is 16%.

What is the NPV if the company purchases the machine today? (Round answer to 2 decimal places. Do not round intermediate calculations)

Topic: Capital Budgeting Project

2.

Your company is deciding whether to invest in a new machine. The new machine will increase cash flow by $330,381 per year. You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will be obsolete 10 years from today. The machine is currently priced at $1,760,000. The cost of the machine will decline by $110,000 per year until it reaches $1,320,000, where it will remain. The required return is 13%.

What is the NPV if the company decides to wait 2 years to purchases the machine? (Round answer to 2 decimal places. Do not round intermediate calculations)

Topic: Real Option to Delay

Answer 1

Net present value is calculated as present value of cash inflow less present value of cash outflow. Present value is calculated by discounting future cash flow with discount rate.
1.
Calculation of net present value is shown below
Year	Cash flow	Discount factor @ 16%		Present value
0	-$1,760,000	1	1/(1.16^0)	-$1,760,000
1	$333,520	0.86207	1/(1.16^1)	$287,517
2	$333,520	0.74316	1/(1.16^2)	$247,860
3	$333,520	0.64066	1/(1.16^3)	$213,672
4	$333,520	0.55229	1/(1.16^4)	$184,200
5	$333,520	0.47611	1/(1.16^5)	$158,793
6	$333,520	0.41044	1/(1.16^6)	$136,891
7	$333,520	0.35383	1/(1.16^7)	$118,009
8	$333,520	0.30503	1/(1.16^8)	$101,732
9	$333,520	0.26295	1/(1.16^9)	$87,700
10	$333,520	0.22668	1/(1.16^10)	$75,604
	Net present value			-$148,021.97
2.
Calculation of net present value today if machine is purchase 2 years from today.
Net present value	[-1540000+(333520*PVIFA(n=8, i=13%))]/1.13^2
Net present value	[-1540000+(333520*PVIFA(n=8, i=13%))]/1.13^2
Net present value	[-1540000+(333520*4.7988))]/1.13^2
Net present value	[-1540000+1600485.87)]/1.2769
Net present value	$47,369.31