You are replacing an old piece of machinery with a new one that offers improved technology and efficiencies to your company. The new machine will cost you $50,000 and it will provide you with a cash inflow of $10,500 PER YEAR for the next 7 years. You can sell the old machine for $6,800 at the time of purchase for the new equipment. The cost of capital for your company is 9%. What is the NPV of the investment? What is the IRR? Do you recommend investing in the new machine?
The School Subject would be accounting or business, probably, but NOT "college." You always want to name the School Subject so the right volunteer teacher reads your post. It is not I!
Sra
To calculate the Net Present Value (NPV) of the investment, we need to calculate the present value of the cash inflows and outflows of the project. The NPV represents the difference between the present value of the inflows and the present value of the outflows.
1. Calculate the cash outflow at time 0:
The purchase price of the new machine is $50,000, but you can also subtract the sale price of the old machine, which is $6,800.
Cash outflow = $50,000 - $6,800 = $43,200
2. Calculate the present value of the cash inflows:
The cash inflow per year is $10,500 for 7 years. We need to calculate the present value of these cash inflows using the cost of capital, which is 9%.
Present Value = Cash inflow / (1 + Cost of Capital)^n
Present Value of cash inflow = $10,500 / (1 + 0.09)^1 + $10,500 / (1 + 0.09)^2 + ... + $10,500 / (1 + 0.09)^7
Using a financial calculator or Excel, we can calculate the present value of the cash inflows to be $59,370.07.
3. Calculate the NPV:
NPV = Present value of inflows - Cash outflow at time 0
NPV = $59,370.07 - $43,200 = $16,170.07
The NPV of the investment is $16,170.07.
To calculate the Internal Rate of Return (IRR), we need to find the discount rate at which the present value of future cash inflows equals the cash outflow at time 0.
Using Excel or a financial calculator, we can find that the IRR is approximately 17.0%.
Based on the positive NPV and the IRR (which is higher than the cost of capital), investing in the new machine is recommended. The investment is expected to generate a positive return, and the present value of the cash inflows exceeds the initial investment cost.