initial investment was $450,000 to buy the equipment.In the second, third, and f
ID: 2796547 • Letter: I
Question
initial investment was $450,000 to buy the equipment.In the second, third, and fourth years, the company net cash flow is expected to be positive, $145,000, $210,000 and $580,000, respectively.The financial rate was rf = 10% and the reinvestment rate rr = 12%.
The amortization rate for the equipment is 20% per year.
Question:Assess the feasibility of the investment by using different methods.Interpret the result obtained by different methods.Make a decision whether you want to make this capital investment.
Explanation / Answer
1) Initial investment = $450000
2) If reinvestment made we can earn = $450000 X 12%
=$54000 it is nothing but opportunity cost
3) Amortisation per year = $450000 X 20%
= $90000 ,it is not relevant because tax rate not given and cashflows are given.
4) it is assumed that asset realisable value at the end of third year is nil.
Capital buget decision making using NPV
NPV is positive hence make inventment and get benefit of $ 156830
Capital budget decision making using IRR Method
IRR is the at which discount rate Discounted cash outflows = Discounted cash inflows
By using excel IRR is 36%
36% is more than reinvestment rate hence investment must be done.
YEAR Cashflows Opportunity cost Net cashflows PVF @10% PV of cash flows 1 145000 54000 91000 0.9091 82728 2 210000 54000 156000 0.8264 128918 3 580000 54000 526000 0.7513 395184 Total 606830 Initial investment 450000 NPV 156830Related Questions
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