A clothing manufacturing firm is deciding whether to invest in a new technology

Question

A clothing manufacturing firm is deciding whether to invest in a new technology that needs an initial investment of $45,000. This will increase cash flows in the first year by $25,000 and $30,000 in the second year. The firm’s current fixed costs are $9,000 and marginal cost is $15. The firm currently charges $18 per unit. If the interest rate is 15% then the net present value of these cash flows is

$6,020.41 ?

$7,380.95

-$7,380.95

-$576.56

$2,826.09

If the interest is 15%, should the firm undertake the investment?

No, since NPV=0

No, since NPV<0

Yes, since NPV<0

Yes, since NPV>0 ?

Explanation / Answer

Ans: -$576.56

Ans: No, since NPV<0

Explanation:

NPV = -45,000 + 25,000(P/F, 15%, 1) + 30,000(P/F, 15%, 2)

        = -45,000 + 25,000(0.8696) + 30,000(0.7561)

        = -45,000 + 21,740 + 22,683

        = -$577             (it is equvalent as $576.56. The difference is due to table value)

Since NPV < 0, the firm should not undertake the investment.

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