Question

Capital Budgeting
Pete's Precision Presses is considering purchasing a new press for $200,000.
The press will save the company $60,000 per year in production costs for 7 years.
After 7 years the press will have a value of $50,000.
Depreciation is calculated over 7 years using straight-line.
1. Calculate the Payback Period
Should the company buy the press if its minimum ARR is 20%?
3. Calculate the Net Present Value (NPV) of the press using 15% interest.
Should the company buy the press using NPV?

Answer 1

Working Note
Statement Showing Calculation of NPV and Payback Period
Year	Detail	Cash Flow	PVF @ 15%	Present Value	Cummulative Cash Flow	PVF@35%	Present Value @35%
0	Cost of Purchasing Press	-$200,000	1.000	-$200,000	-$200,000	1	-$200,000
1	Annual Cash Flow	$70,000	0.86957	$60,870	-$139,130	0.740741	$51,852
2	Annual Cash Flow	$70,000	0.75614	$52,930	-$86,200	0.548697	$38,409
3	Annual Cash Flow	$70,000	0.65752	$46,026	-$40,174	0.406442	$28,451
4	Annual Cash Flow	$70,000	0.57175	$40,023	-$152	0.301068	$21,075
5	Annual Cash Flow	$70,000	0.49718	$34,802	$34,651	0.223014	$15,611
6	Annual Cash Flow	$70,000	0.43233	$30,263	$64,914	0.165195	$11,564
7	Annual Cash Flow	$70,000	0.37594	$26,316	$91,229	0.122367	$8,566
7	Residual Value	$50,000	0.37600	$18,800	$110,029	0.122367	$6,118
	Net present Value			$110,029			-$18,355
	Pay back Period	4 Year ( Approx)
NPV is Positive , Hence Press Should be Purchased
1	Pacy Back period	4 Year (Approx)
2	IRR=     Lower discount rate            +	Lowere rate NPV                   *			(Higher Rate- lower Rate)
		Lowere rate NPV- Higher rate NPV
	IRR=                               15%            +	110029			(35%-15%)
		$110029-(-$18355)
	IRR= 32.14%
	ARR is 20%
	ARR is less then IRR hence, Compamny should not buy the project
3	NPV @ 15%	$110,029
	NPV is Positive hence Company Can buy the Press