Question

The president of Leather Craft, Inc., has asked his finance manager to evaluate the proposal to purchase a leather stretching device to be used when manufacturing leather bags. The machine requires an initial investment of $24,000 and will generate cash inflows of $5,000 per year for 8 years.

For each of the costs of capital listed

• The cost of capital is 10%
  • Calculate the net present value (NPV):
  • Indicate whether to accept or reject the machine:
  • Explain your decision:
• The cost of capital is 12%
  • Calculate the net present value (NPV):
  • Indicate whether to accept or reject the machine:
  • Explain your decision:
• The cost of capital is 15%
  • Calculate the net present value (NPV):
  • Indicate whether to accept or reject the machine:
  • Explain your decision:

Answer 1

The president of Leather Craft, Inc., has asked his finance manager to evaluate the proposal to purchase a leather stretching device to be used when manufacturing leather bags. The machine requires an initial investment of $24,000 and will generate cash inflows of $5,000 per year for 8 years.

For each of the costs of capital listed

The cost of capital is 10%

Calculate the net present value (NPV):

Years	CF	PV factor @10%	PV of CF
Initial investment	24000	1	24000
Cash flow of year 1 to year 8 (annuity)	5000	( 1 / 1 + 10%)8GT = 5.335	26674.63

GT = Grand total ( calculator function)

NPV = PV of cash flow - initial investment

NPV = 26674.63 - 24000 = $ 2675

Indicate whether to accept or reject the machine:  Accept

Explain your decision: Because, NPV is positive. If company accept a project with positive NPV, It will add values to the business, and increase the wealth of share holders.

The cost of capital is 12%

Calculate the net present value (NPV):

Years	CF	PV factor @10%	PV of CF
Initial investment	24000	1	24000
Cash flow of year 1 to year 8 (annuity)	5000	( 1 / 1 + 12%)8GT = 4.9676	24838

GT = Grand total ( calculator function)

NPV = PV of cash flow - initial investment

NPV = 24838 - 24000 = $ 838

Indicate whether to accept or reject the machine:  Accept

Explain your decision: Because, NPV is positive. If company accept a project with positive NPV, It will add values to the business, and increase the wealth of share holders.

The cost of capital is 15%

Calculate the net present value (NPV):

Years	CF	PV factor @10%	PV of CF
Initial investment	24000	1	24000
Cash flow of year 1 to year 8 (annuity)	5000	( 1 / 1 + 15%)8GT = 4.4893	22436.60

GT = Grand total ( calculator function)

NPV = PV of cash flow - initial investment

NPV = 22436.60 - 24000 = -- $ 1563

Indicate whether to accept or reject the machine:  Reject

Explain your decision: Because, NPV is negative. If company accept a project with negative NPV, It will reduce the values of business, and decrease the wealth of share holders.