Question

Given the following information, calculate the Present Value Index for a capital budget proposal. Show your work. Machine Cost: $6,000,000 Salvage Value: $50,000 Setup Costs: $45,000 Training Costs: $25,000 Annual maintenance costs: $45,000 Anticipated annual savings: $560,000 Annual labor savings: $25,000 Expected useful life in years: 12 Overhaul costs in year 4: $50,000 Annual operating costs: $25,000 Hurdle rate: 8%

Answer 1

Present value index =Present value of future cash flows/Initial investment Calculation of initial investment Machine cost        6,000,000 Setup cost 45000 Total initial Investment        6,045,000 Calculation of Present value of future cashflows Year Particulars Cash inflow/(cash outflow) present value factor@8% Present value of future cashflows 1-12 Annual maintained cost                                    (45,000) 7.536                                        (339,120.00) 1-12 Anticipated Annual savings                                    560,000 7.536                                       4,220,160.00 1-12 Annual labor savings                                      25,000 7.536                                          188,400.00 1-12 Annual operating cost                                    (25,000) 7.536                                        (188,400.00) 4 Overhaul cost                                    (50,000) 0.735                                           (36,750.00) 12 salvage value                                      50,000 0.397                                            19,850.00 Present value of future cashflows                                      3,864,140.00 Present value Index =Present value of future cashflows/Initial Investment =3,864,140/6,045,000 =   0.639 Since present value index less than one the capital budge proposal is profitable