Question

Marigold Industries is considering the purchase of new equipment costing $420,000 to replace existing equipment that will be sold for $63,000. The new equipment is expected to have a $70,000 salvage value at the end of its 1-year life. During the period of its use, the equipment will allow the company to produce and sell an additional 10,500 units annually at a sales price of $7 per unit. Those units will have a variable cost of $4 per unit. The company will also incur an additional $31,500 in annual fixed costs.

Click here to view the factor table.

(a) Calculate the net present value of the proposed equipment purchase. Assume that Marigold uses a 4% discount rate. (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to 0 decimal place, e.g. 58,971. Enter negative amount using a negative sign preceding the number e.g. -59,992 or parentheses e.g. (59,992).)

Net present value

(b) Do you recommend that Marigold Industries invest in the new equipment?

Answer 1

Answer a : Net present value = ($289,695)

Explanation :

Note 1 : Initial investment = New equipment cost - Selling price of old equipment

= $420,000 - $63,000 = $357,000

Note 2 : Annual cash flows = [(Selling price per unit - Variable cost per unit) * Unit sold] - Fixed costs

= [($7 - $4) * 10,500 units] - $31,500 = 0

Note 3 : Salvage value of new equipment at the end of its 1-year life = $70,000

Computation of Net present value

Particular	Year	PV factor@ 4% discount rate	Working	Present Value
Initial investment (Note 1)	0	1	[$357,000 * 1]	(357,000)
Annual cash flows (Note 2)	1	0.9615	[0 * 0.9615]	0
Salvage value of new equipment (Note 3)	1	0.9615	[$70,000 * 0.9615]	$67,305
Net present value				($289,695)

Answer b : No , Marigold Industries should not invest in the new equipment.

Explanation: Since the npv is negative Marigold Industries should not invest in the new equipment