Cooper construction is considering purchasing new technologically advanced equipment. The equipment will cost $625,000 with a salvage value $50,000 and the end of 10 years. The equipment is expected to general additional annual cash inflows with the following probabilities for the next 10 yrs; Probabililty Cash Flow
.15 $60,000
.25 $85,000
.45 $110,000
.15 $130,000
What is expected Cash flow I got $99,250. Cost of Capital 10%, what is expected net present value? My question is do I multiple $625,000 by present values of .909, .826 .751 each by $625,000 or will this value change?
99250
To calculate the expected net present value (NPV) of the equipment purchase decision, you need to first calculate the expected cash flows for each year, and then discount those cash flows to the present value using the cost of capital.
To calculate the expected cash flow, you multiply each possible cash flow by its corresponding probability and sum up the results. From the information provided, the expected cash flow can be calculated as follows:
Expected Cash Flow = (.15 * $60,000) + (.25 * $85,000) + (.45 * $110,000) + (.15 * $130,000)
= $9,000 + $21,250 + $49,500 + $19,500
= $99,250
So you have correctly calculated the expected cash flow as $99,250.
Now, to calculate the expected net present value (NPV), you need to discount each expected cash flow to the present value using the cost of capital of 10%. The present value factor for each year can be calculated as (1 / (1 + r)^t), where r is the discount rate (cost of capital) and t is the number of years.
The present value factor for each year, assuming a 10% cost of capital, can be calculated as follows:
Year 1: 1 / (1 + 0.1)^1 = 0.909
Year 2: 1 / (1 + 0.1)^2 = 0.826
Year 3: 1 / (1 + 0.1)^3 = 0.751
(repeat this for each year up to 10 years)
Now, to calculate the expected NPV, you multiply each present value factor by the expected cash flow and sum up the results. In this case, you would multiply each present value factor by $99,250 (the expected cash flow).
Expected NPV = ($99,250 * 0.909) + ($99,250 * 0.826) + ($99,250 * 0.751) + ...
= ($90,122.25) + ($81,769.50) + ($74,501.75) + ...
Continue this calculation for each year up to 10 years, and then sum up all the present values to get the expected NPV.
So, to answer your question, you would multiply each present value factor by $625,000 (the cost of the equipment) and then sum up the results to calculate the expected NPV.