A financial manager is considering a proposal from the Chief Operating Officer (

Question

A financial manager is considering a proposal from the Chief Operating Officer (COO) to purchase precision testing equipment. The financial manager with the assistance of operating personnel has estimated the cash flow benefits, namely the cost savings from fewer production defects, of the new equipment. The Present Value (PV) of the these positive cost savings over the next 10 years is estimated to be $755,000 based on the firm's cost of capital of 8%. Which of the following statements is true?

A. If the total cost of the equipment, including the costs of installation and set up, are equal to or less than the estimated PV of the cost savings $755,000, the financial manager should recommend the proposal to the COO and senior management.

B. If the total cost of the equipment, including the costs of installation and set up, are significantly greater than the estimated PV of the cost savings $755,000, the financial manager should recommend the proposal to the COO and senior management.

C. If the total cost of the equipment, including the costs of installation and set up, are significantly greater than the estimated PV of the cost savings $755,000, the financial manager should NOT recommend the proposal to the COO and senior management.

D. If the total cost of the equipment, including the costs of installation and set up, are equal to or less than the estimated PV of the cost savings $755,000, the financial manager should NOT recommend the proposal to the COO and senior management.

A. If the total cost of the equipment, including the costs of installation and set up, are equal to or less than the estimated PV of the cost savings $755,000, the financial manager should recommend the proposal to the COO and senior management.

Explanation / Answer

Net present value = PV of cash inflows and PV of cash outflows

If a project has positive NPV or ZERO NPV, firm should condering accepting the project.

PV of cash inflows was $755,000

PV of cash outflows are costs of installation and set up.

So costs of installation and set up should be equal to or less than the $755,000 to accept the project.

Hence, correct option is Answers A. and C.

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