Question

1. Wood Products Company would like to purchase a computerized wood lathe for $100,000. The machine is expected to have a life of 5 years, and a salvage value of $5,000. Annual maintenance costs will total $20,000. Annual cash receipts resulting from this machine are predicted to be $45,000. The company’s required rate of return is 15 percent.

1. Use Excel to calculate the net present value. (7.2)
2. Use Excel to calculate the internal rate of return. (7.3)
3. Based on your answer from parts a) and b), should the company purchase the wood lathe? Explain. (7.2, 7.3, 7.4)

Answer 1

A and B.

Cost of wood lath	$          100,000
Annual cash receipt	$            45,000
Maintenance cost	$            20,000
Rate	15%
Year	Cash receipts	Annual maintenance cost	Salvage	Net annual cash flow
0	$       (100,000)			$       (100,000)
1	$            45,000	$        (20,000)		$            25,000
2	$            45,000	$        (20,000)		$            25,000
3	$            45,000	$        (20,000)		$            25,000
4	$            45,000	$        (20,000)		$            25,000
5	$            45,000	$        (20,000)	$        5,000	$            30,000
NPV	$    (13,710.24)
IRR	9.18%

Formula view:

Cost of wood lath	100000
Annual cash receipt	45000
Maintenance cost	20000
Rate	0.15
Year	Cash receipts	Annual maintenance cost	Salvage	Net annual cash flow
0	-100000			=SUM(E9:G9)
1	45000	-20000		=SUM(E10:G10)
2	45000	-20000		=SUM(E11:G11)
3	45000	-20000		=SUM(E12:G12)
4	45000	-20000		=SUM(E13:G13)
5	45000	-20000	5000	=SUM(E14:G14)
NPV	=NPV(E6,H10:H14)+E9
IRR	=IRR(H9:H14)

C.

NPV = Net present value of the investment = Negative

IRR = Future expected return of the project = less than the required rate of return

Hence, the company should not purchase the wood lathe.