Gamma Electronics is considering the purchase of testing equipment that will req

Question

Gamma Electronics is considering the purchase of testing equipment that will require an initial outlay (cost) of $500,000 to replace old equipment. The purchase of this new equipment will result in a positive after-tax cash benefit/in-flow of $200,000 at the end of each year, for the next four years. If Gamma Electronics has a 10% cost of capital, what's the Net Present Value (NPV) of the investment?

a) $213,745

b) $259,250

c) $159,250

d) $134,000

Referring to the Gamma Electronics cash flow scenario discussed above, if Gamma Electronics has a 12% cost of capital, what's the profitability index of the investment?

a)1.22

b)1.43

c)1.52

d)1.00

Explanation / Answer

(a) NPV

Correct option (d)

(b) Profitability Index (PI)

PI = PV of future cash inflows / Initial investment

PI = $607,470 / $500,000 = 1.22

Option (a)

Year Cost ($) Annual Cash Flow ($) Discount Factor @10% Discounted Cash Flow ($) 0 -5,00,000 1.0000 -5,00,000 1 2,00,000 0.9091 1,81,818 2 2,00,000 0.8264 1,65,289 3 2,00,000 0.7513 1,50,263 4 2,00,000 0.6830 1,36,603 PV of Cash Inflows = 6,33,973 NPV = 1,33,973

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