Question

Net Present Value Method

The following data are accumulated by Geddes Company in evaluating the purchase of $137,200 of equipment, having a four-year useful life:

	Net Income		Net Cash Flow
Year 1	$32,000		$54,000
Year 2	20,000		42,000
Year 3	9,000		31,000
Year 4	(1,000)		21,000

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

a. Assuming that the desired rate of return is 10%, determine the net present value for the proposal. Use the table of the present value of $1 presented above. If required, round to the nearest dollar. Present value of net cash flow Amount to be invested Net present value b. Would management be likely to look with favor on the proposal? ,because the net present value indicates that the return on the proposal is than the minimum desired rate of return of 10%.

Answer 1

Solution:

a)

Purchase price of equipment = 137,200

Required rate if return = 10%

Assume that equipment is purchased at the beginning of the year and the cash flows are occured at the end of the year

Present value of net cash flow = 121,402

Less : amount to be invested   = 137,200

Net present value                        = -15,798

Calculation of present value of Net cash flow

Year	Cash flow	PV factor @ 1	Discounted cashflow
1	54,000	0.909	49,086
2	42,000	0.826	34,692
3	31,000	0.751	23,281
4	21,000	0.683	14,343
Total present value of net cashflow			121,402

b)

No , present value indicates that the return on proposal is less than the minimum desired return of 10%