Head, Inc. is deciding whether to automate one phase of its production process.

Question

Head, Inc. is deciding whether to automate one phase of its production process. The equipment has a six-year life and will cost $450,000. Projected net cash inflows are as follows: Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Head, Inc.’s $130,000 $125,000 $110,000 $100,000 $95,000 $90,000 hurdle rate is 12%. Assume residual value is zero

1. Compute the project’s NPV.

2. If Head, Inc. decides to refurbish the equipment at a cost of $50,000 at the end of the 6th year, it could be used for one more year providing $40,000 of net cash inflows and would have a $30,000 residual value. What is the NPV of the refurbishment?

3. Should Head, Inc. refurbish the equipment after 6 years? Support your answer.

Explanation / Answer

1.

2.

3.

Head Inc. can refurbish the equipment after 6 years. then they will get an additional benefit of $6,332.89

Year Net cash inflow PV Factor Present value of net cash inflow 1 130000 0.892857143                                             1,16,071.43 2 125000 0.797193878                                                 99,649.23 3 110000 0.711780248                                                 78,295.83 4 100000 0.635518078                                                 63,551.81 5 95000 0.567426856                                                 53,905.55 6 90000 0.506631121                                                 45,596.80 PV of net cash inflow                                             4,57,070.65 Less: Investments                                            -4,50,000.00 NPV                                                   7,070.65

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