Question

Chicago Cola is considering the purchase of a special-purpose bottling machine for $24,000. It is expected to have a useful life of 4 years with no terminal disposal value. The plant manager estimates the following savings in cash operating costs: (Click the icon to view the savings in cash operating costs.) Chicago Cola uses a required rate of return of 18% in its capital budgeting decisions. Ignore income taxes in your analysis. Assume all cash flows occur at year-end except for initial investment amounts Present Value of $1 table Present Value of Annuity of $1 table Future Value of $1 table Future Value of Annuity of $1 table Read the requirements 1. Net present value. (Use factor amounts rounded to three decimal places. Round your answers to the nearest whole dollar. Use a minus sign or parentheses for a negative net present value.) The net present value is $ .

Answer 1

Solution

Year	Annual Cost Savings	CFAT	Cumulative CFAT	PVIF @ 18%	Discounted CFAT	Cumulative Discounted CFAT
1	$                   11,000.00	$ 11,000.00	$            11,000.00	0.8475	$              9,322.03	$                                        9,322.03
2	$                     9,000.00	$   9,000.00	$            20,000.00	0.7182	$              6,463.66	$                                      15,785.69
3	$                     7,000.00	$   7,000.00	$            27,000.00	0.6086	$              4,260.42	$                                      20,046.11
4	$                     4,000.00	$   4,000.00	$            31,000.00	0.5158	$              2,063.16	$                                      22,109.27
Total Discounted CFAT					$            22,109.27
Less: Initial Investment					$          -24,000.00
NET PRESENT VALUE					$             -1,890.73

(1) Net Present Value will be $ (-) 1,890.73

(2) Cash Payback Period: From the Cumulative CFAT column, it can be observed that Initial Outflow of $ 24,000 will be recovered in 2 to 3 years. So, assuming at Xth year the Cumulative Cash Flow should be $ 24,000, value of X using Interpolation,

(X-2)/(3-2) = (24000-20000)/(27000-20000)

Or, (X-2) = 4000/7000

Or, X-2 = 0.57 (Approx)

Or, X = 2.57

Therefore Cash Payback Period = 2.57 Years

(3) Discounted Payback Period: If referred to the Cumulative Discounted CFAT column, it is clearly seen that the company is not able to recover its initial outlay in the given time frame. Hence, Discounted Payback Period could not be calculated.

Note: The CFAT is actually Annual Cost Savings, not revenue. Hence the depreciation effect has nothing to do with this calculation.