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 $14,800 and has an economic life of five years. The machine will generate cash flows of $3,800 (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 10 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 for the Total Over 5 Years = $4,200

Accounting Income = Cash Flow – Depreciation

Depreciation = $14,800 / 5 Years = $2,960

Accounting Income = $3,800 - $2,960 = $840

Accounting Income for the Total Over 5 Years = $840 x 5 = $4,200

(b)Net present value (NPV) at 10% = -$394 (Negative)

= [ $3800 x (PVAF 10%,5 Years) ] - $14,800

= [ $3800 x 3.791 ] - $14,800

= $14,406 - $14,800

= -$394 (Negative)

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