Prince Company\'s required rate of return is 10%. The company is considering the

Question

Prince Company's required rate of return is 10%. The company is considering the purchase of three machines, as indicated below. Consider each machine independently. (Ignore income taxes in this problem.)

           

Required:

a) Machine A will cost $25,000 and will have a useful life of 15 years. Its salvage value will be $1,000, and cost savings are projected at $3,500 per year. Calculate the machine's net present value.

b) How much should Prince Company be willing to pay for Machine B if the machine promises annual cash inflows of $5,000 per year for eight years?

c)    Machine C has a projected life of ten years. What is the machine's internal rate of return if it costs $31,296 and will save $6,000 annually in cash operating costs? Would you recommend to Prince Company to purchase Machine C? Explain.

Explanation / Answer

a). Machine A

Intial Cost= $25,000

Useful Life = 15 yrs

Annual cost savings = 3500

Salvage Value = 1000

Required rate of return = 10%

b).Machine B:

Annual Cash Inflows: $5000

Useful Life :8years

NPV of Cash inflows = 5000* (10%,8 yrs factor)

=5000*0.467

=$2335

c).Machine C:

Useful Life=10 years

Cost = $ 31,296

Annual cost savings= $6000

Internal Rate of Return = Investment required/ Net annual cash savings

= 31,296/6000

=5.216

After computing Internal rate of retun factor,the next step is to locate this discount factor in present value of annuity table which is 14%.

Since,the internal rate of return promised by machine C (14%) is more than minimum required rateof return(10%),so Machine C should be purchased.

Item Years Amount 10% factor Present value of Cash Savings Annual Cost savings 1-15 3500 7.606 26,621 Salvage Value 1000 0.239 239 Intial cost (25,000) 1.000 (25,000) NPV 1860

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.