Question

The management of Electronics Company is considering to purchase an equipment to be attached with the main manufacturing machine. The equipment will cost $8,000. The useful life of the equipment is 4 years. Management projected that annual cash inflow for four(4) years as follow: year-1 $1,000, year-2 $3000, year-3 $3500 and year-4 $4000. There’s maintenance cost for the equipment, and management should expense: $600 on year-2 and $800 on year-4. The management wants a 14% return on all investments. a. Compute net present value (NPV) of this investment. b. Should the equipment be purchased according to NPV analysis?

Answer 1

a) Rate of return = 14%

Initial cost = 8,000

Year	Inflow	Present value of inflow	Rough work to calculate present value
1	1,000	877.19	[1,000 / 1.14^1]
2	3,000	2,308.40	[3,000 / 1.14^2]
3	3,500	2,362.40	[3,500 / 1.14^3]
4	4,000	2,368.32	[4,000 / 1.14^4]
		7,916.32

Present value of maintenance cost in year 2 = [600 / 1.14^²] = 461.68

Present value of maintenance cost in year 4 = [800 / 1.14^⁴] = 473.66

Present value of maintenance cost in both years = 461.68 + 473.66 = 935.34

Net present value = -Initial cost + Present value of inflow - Present value of annual cost = -8,000 + 7,916.32 - 935.34 = -1,019.02

b) As the net present value is in negative, this investment is not economically justified.