A-15 Compute Net Present Value; Compare to Accounting Income Lucas Company is co

Question

A-15 Compute Net Present Value; Compare to Accounting Income Lucas Company is considering investing in a new machine. The machine costs $12,500 and has an economic life of five years. The machine will generate cash flows of $3,000 (cash revenues less cash expenses) each year. All cash flows, except for the initial investment, are realized at the end of the year. The investment in the machine will be made at the beginning of the first year. Lucas is not subject to any taxes and, for financial accounting purposes, will depreciate the machine using straight-line depreciation over five years. Lucas uses a 8 percent cost of capital when evaluating investments. Use Exhibit A.9. Required: a. Calculate the accounting income for the total over five years Accounting income b. Compute the NPV of the cash flows over five years. (Round PV factor to 3 decimal places Negative amount should be indicated by a minus sign.) Net present value

Explanation / Answer

a). Accounting Income :-
Life of project = 5 years
Cash inflows (revenues) each year = $3000
Depreciation using SLM = $12500 / 5 = $2500 per annum.

Accounting Income = Cash inflows - Depreciation
= $3000 - $2500 = $500 per annum.
Accounting Income for the total over 5 years = $500 * 5 = $2500.

b). Net Present Value :-
Initial Investment = $12500
Annual cash inflows = $3000
Present value of cash Inflows of 5 years = Cash Inflow * Present Value Annuity Factor 8% 5 yrs.
= $3000 * PVAF 8% 5 yrs.
= $3000 * 3.99271
= $11,978.13

NPV = Present value of cash inflows - Initial Investment
NPV = $11978.13 - $12500
NPV = - $521.87

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