Question

Net Present Value

Use Exhibit 12B.1 and Exhibit 12B.2 to locate the present value of an annuity of $1, which is the amount to be multiplied times the future annual cash flow amount.

Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.

1. Campbell Manufacturing is considering the purchase of a new welding system. The cash benefits will be $480,000 per year. The system costs $2,150,000 and will last 10 years.
2. Evee Cardenas is interested in investing in a women's specialty shop. The cost of the investment is $280,000. She estimates that the return from owning her own shop will be $40,000 per year. She estimates that the shop will have a useful life of 6 years.
3. Barker Company calculated the NPV of a project and found it to be $63,900. The project's life was estimated to be 8 years. The required rate of return used for the NPV calculation was 10%. The project was expected to produce annual after-tax cash flows of $135,000.

Required:

1. Compute the NPV for Campbell Manufacturing, assuming a discount rate of 12%. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV.

Should the company buy the new welding system?

2. Conceptual Connection: Assuming a required rate of return of 8%, calculate the NPV for Evee Cardenas' investment. Round to the nearest dollar. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV.

Should she invest?

What if the estimated return was $135,000 per year? Calculate the new NPV for Evee Cardenas' investment. Would this affect the decision? What does this tell you about your analysis? Round to the nearest dollar.

The shop   be purchased. This reveals that the decision to accept or reject in this case is affected by differences in estimated  

3. What was the required investment for Barker Company's project? Round to the nearest dollar. If required, round all present value calculations to the nearest dollar.

Answer 1

1. Compute the NPV as follows: -

The NPV is $562,107.

Conclusion: The company should buy the new welding machine as it has a positive NPV.

Note: It has been assumed that the welding machine does not have any salvage value at the end of its' useful life.

2. Compute the NPV as follows: -

The NPV is -$95,085.

Conclusion: The company should not buy the new shop as it has a negative NPV.

Note: It has been assumed that the investment does not have any salvage value at the end of its' useful life.

Compute the NPV as follows: -

The NPV is $344,089.

Conclusion: The company should buy the new shop as it has a positive NPV.

Note: It has been assumed that the investment does not have any salvage value at the end of its' useful life.

3. Compute the required investment as follows: -

NPV = Present Value of after-tax cash flows - Required Initial Investment

Required Initial Investment = Present Value of after-tax cash flows - NPV

= (Annual After-tax Cash Flows x Annuity factor for 8 years at 10%) - NPV

= ($135,000 x 6.1446) - $63,900

=$765,617

Therefore, required initial investment is $765,617.