Question

Suppose your company is thinking of purchasing a new assembly line for $900,000 in initial investment cost.The current interest rate is 6 percent.The new line is expected to last for four years and has no salvage value. It is anticipated that the new line will generate the following cash flows:  

            Year 1                         $500,000

            Year 2                         $375,000

            Year 3                         $  25,000

            Year 4                         $  20,000

1. This sums to greater than $900,000. Shouldn’t the company buy the assembly line? Why or why not? ( don't have to answer this question)

-> 2. Regardless of how you answered, use net present value analysis to calculate the NPV for this project.  Now, do you think the company should purchase the new line?  Show your work.  

Answer 1

The NPV method is used to generate the present value of the future cash flows with the help of the discounting rates.

To decide whether to adopt the new line or not we will perform the following calculations-:

31So00 2 Sooo 20000 ea 3 (l.og)l (1.00). (!.06)3 (I.ヅ 812219 Cappio-) 1. 0 6

Now from the above calculation we get the NPV = $842279 (approx) with the discounting rate of 6%.p.a.

The new line is costing less than the assembly line which costs to $900000. So it will be beneficial to adopt the new line because the NPV from the new line of the investment is less than the cost of the original assembly line.

Hence the new line should be adopted.