Question

IBX Pty Ltd is considering the purchase of a new machine that is expected to save the company $81,000 at the end of each year in reduced wages. The machine costs $261,000, plus another $15,000 to be installed. It is expected to last for five years after which it can be sold as scrap for $47,000. Operating expenses (such as fuel and maintenance) are $7,000 pa.

a)Determine the annual net cash flows of this investment (ignore the effect of taxes). Enter the information in the following table. Indicate whether cash flows are + or -:

Time 0 1 2 3 4 5

Net Cash Flow ____________ _________ _______ ________ ________ ____________

b)Calculate the NPV if the required rate of return is 13% pa. Give your answer in dollars and cents to the nearest cent. NPV13% = $ _________

c)Calculate the NPV if the required rate of return is 15% pa. Give your answer in dollars and cents to the nearest cent. NPV15% = $__________

Answer 1

Solution :

a)The annual net cash flows of this investment is :

Time	0	1	2	3	4	5
Net cash flow	- $ 276,000	$ 74,000	$ 74,000	$ 74,000	$ 74,000	$ 121,000

Year 0 Net cash flow = Machine purchase cost + Installation cost = - $ 261,000 -  $ 15,000 = - 276,000

Year 1 Net cash flow = Savings in wages – Operating expenses = $ 81,000 - $ 7,000 = $ 74,000

Year 2 Net cash flow = Savings in wages – Operating expenses = $ 81,000 - $ 7,000 = $ 74,000

Year 3 Net cash flow = Savings in wages – Operating expenses = $ 81,000 - $ 7,000 = $ 74,000

Year 4 Net cash flow = Savings in wages – Operating expenses = $ 81,000 - $ 7,000 = $ 74,000

Year 5 Net cash flow = Savings in wages – Operating expenses + Salvage value

= $ 81,000 - $ 7,000 + $ 47,000 = $ 121,000

b) The NPV if the required rate of return is 13% pa = $ 9,784.83

c) The NPV if the required rate of return is 15% pa = - $ 4,573.22

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.