Question

Use Exhibit 12B.1 and Exhibit 12B.2 to locate the present value of an annuity of $1, which is the amount to be multiplied times the future annual cash flow amount.

Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.

Campbell Manufacturing is considering the purchase of a new welding system. The cash benefits will be $480,000 per year. The system costs $2,350,000 and will last 10 years.

Evee Cardenas is interested in investing in a women's specialty shop. The cost of the investment is $280,000. She estimates that the return from owning her own shop will be $55,000 per year. She estimates that the shop will have a useful life of 6 years.

Barker Company calculated the NPV of a project and found it to be $63,900. The project's life was estimated to be 8 years. The required rate of return used for the NPV calculation was 10%. The project was expected to produce annual after-tax cash flows of $135,000.

Required:

1. Compute the NPV for Campbell Manufacturing, assuming a discount rate of 12%. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV.
$

Should the company buy the new welding system?
Yes

2. Conceptual Connection: Assuming a required rate of return of 8%, calculate the NPV for Evee Cardenas' investment. Round to the nearest dollar. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV.
$

Should she invest?
Yes

What if the estimated return was $135,000 per year? Calculate the new NPV for Evee Cardenas' investment. Would this affect the decision? What does this tell you about your analysis? Round to the nearest dollar.
$

Answer 1

NPV = PV of Cash Inflow - Intial Investment

1. NPV for Campbell Manufacturing

Cash Inflow = $480,000 per year.

Time = 10 years

Intial Investment = $2,350,000

NPV = $480,000*PVIFA for 10years @ 12% = $480,000*6.32825 = $3,037,560

NPV = PV of Cash Inflow - Intial Investment

= $3,037,560 - $2,350,000 = $687,560

So, as the NPV is positive, the company buy the new welding system

2.

NPV for Evee Cardenas

Cash Inflow = $55,000 per year.

Time = 6 years

Intial Investment = $280,000

NPV = $55,000*PVIFA for 6years @ 8% = $55,000*4.99271= $274,599

NPV = PV of Cash Inflow - Intial Investment

= $274,600 - $280,000 = - $5,400

So, as the NPV is negative, she must not invest in a women's specialty shop.

If the estimated return was $135,000 per year

i.e. New Cash Inflow = $135,000 per year.

Time = 6 years

Intial Investment = $280,000

NPV = $135,000*PVIFA for 6years @ 8% = $135,000*4.99271= $674,016

New NPV = PV of Cash Inflow - Intial Investment

= $674,016 - $280,000 = $394,016

So, as the NPV is positive, she must invest in a women's specialty shop.

As the Cash Inflow is changed the decision also varied from not investing to investing in the shop.