Question

6. The Tool Box needs to purchase a new machine costing $1.46 million. Management is estimating the machine will generate cash inflows of $223,000 the first year and $600,000 for the following three years. If management requires a minimum 12 percent rate of return, should the firm purchase this particular machine? Why or why not?

Answer 1

Answer :should the firm purchase this particular machine? = YES. Because, the net present value of this machine is positive. That means, it results in net income which is more than the required rate of returns (i.e. the income from this machine is >12%).

Solution :

Net present value = present value cash inflows - present value of cash outflows.

= $1485816.7 - $1460000 = $25816.7

Present value of cash inflows at the the rate of 12%:

Year	cash inflows	present value factor at 12%	present value of cash inflows
1	$223000	0.8929	$199116.7
2	$600000	0.7972	$478320
3	$600000	0.7118	$427080
4	$600000	0.6355	$381300
Total			$1485816.7

Present value factor = 1/(1+r)ⁿ  

Where,

r is rate of returns and n is number of years.

So,

Present value factor for year 1 = 1/(1+0.12)¹ = 1/(1.12) = 0.8929

Present value factor for year 2 = 1/(1.12)² = 1/(1.2544) = 0.7972

Present value factor for year 3 = 1/(1.12)³ = 1/(1.4049) = 0.7118

Present value factor for year 4 = 1/(1.12)⁴ = 1/(1.5735) = 0.6355