Question

The One Ring company, a leading producer of fine cast silver jewelry, is considering the purchase of new casting equipment that will allow it to expand its product line. The up-front cost of the equipment is $750,000. The company expects that the new equipment will produce a steady income throughout its 10-year life. a) If One Ring requires a 12% return on its investment, what minimum yearly cash inflow will be necessary for the company to go forward with this project? b) How would the minimum yearly cash inflow change if the company required a 14% return on its investment?

Answer 1

Calculation of Annual cash inflow @12%
Upfront cost of equipment =				750000
Required rate of return			12% or	0.12
Time (n) =				10	Years
To purchase equipment , present value of yearly cash flows to be equal to cost of equipment.
Present value of cash inflows = P * (1 - (1/(1+i)^n) / r
750000 = P * (1 - (1/(1.012)^10) / 0.12
750000 = P * 5.650223
p =	132738.12
So, Minimum Yearly cash inflows necessary for the company to go forward for this project is $132,738.12.
Calculation of Annual cash inflow @14%
Upfront cost of equipment =				750000
Required rate of return			14% or	0.14
Time (n) =				10
To purchase equipment , present value of yearly cash flows to be equal to cost of equipment.
Present value of cash inflows = P * (1 - (1/(1+i)^n) / r
750000 = P * (1 - (1/(1.014)^10) / 0.14
750000 = P * 5.452733
p =	137545.7
So, Minimum Yearly cash inflows necessary for the company to go forward for this project is $137,545.70