The management of Kunkel Company is considering the purchase of a $34,000 machine that would reduce operating costs by $9,000 per year. At the end of the machine’s five-year useful life, it will have zero scrap value. The company’s required rate of return is 12%.
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.
Required:
- Determine the net present value of the investment in the machine.
Net present Value
- What is the difference between the total, undiscounted cash inflows and cash outflows over the entire life of the machine? (Any cash outflows should be indicated by a minus sign.)
Item Cahs Flow Years Total Cash Flows
Annual Cost Savings $900 5 $45,000
Inital investment 1
Net Cash Flow
The Correct Answer and Explanation is :
Answers:
- Net Present Value (NPV):
The net present value (NPV) of the investment in the machine is approximately -$1,557.01. This means that, considering the company’s required rate of return of 12%, the purchase of the machine will result in a net loss of around $1,557.01 over its 5-year life. - Difference Between Total Cash Inflows and Outflows:
- Total Cash Inflows: The machine generates $9,000 in annual savings for 5 years, leading to total cash inflows of $45,000.
- Total Cash Outflows: The initial investment cost of the machine is -$34,000.
- Net Cash Flow Difference: The difference between total cash inflows and outflows is $11,000. This is the simple difference before accounting for the time value of money.
Explanation:
The NPV calculation takes into account the time value of money by discounting future cash inflows. The annual cost savings of $9,000 are expected for five years, but when discounted at the required rate of return (12%), their present value is lower than the initial investment of $34,000, leading to a negative NPV of about $1,557. This negative NPV suggests that, under these conditions, the investment would not generate enough value to meet the company’s required rate of return.
The simple cash flow differenc
