Question

Exercise 11-6 Net present value LO P3

A new operating system for an existing machine is expected to cost $640,000 and have a useful life of six years. The system yields an incremental after-tax income of $255,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $23,200.

A machine costs $390,000, has a $38,300 salvage value, is expected to last eight years, and will generate an after-tax income of $76,000 per year after straight-line depreciation.

Assume the company requires a 10% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.) Round PV to 4 decimal places

	Cash Flow Select Chart Amount x PV Factor = Present Value Annual cash flow Present Value of an Annuity of 1 = $0 Residual value = 0 Net present value

	Cash Flow Select Chart Amount x PV Factor = Present Value Annual cash flow = $0 Residual value = 0 Net present value

Answer 1

First project

Depreciation = (640000-23200)/6 = 102800

Annual cash flow = 255000+102800 = 357800

Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual cash flow	Present Value of an Annuity of 1	357800		4.35526	=	1,558,312.0280
Residual value	Present value of $1	23200		0.56447	=	13,095.7040
	Present value of future cash flows					1,571,407.7320
	Less investment					(640,000.0000)
	Net present value				931,407.7320

Second project:

Depreciation	43,962.50
Rate	10%
Life in years	8
Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual cash flow	Present Value of an Annuity of 1	119,962.50		5.33493	=	639,991.5401
Residual value	Present value of $1	38300		0.46651	=	17,867.3330
	Present value of future cash flows					657,858.8731
	Less investment					(390,000.0000)
	Net present value				267,858.8731