Question

1. You own a coffee shop and are trying to decide whether to invest in a machine that makes, in one step, soy grandé gluten-free, nut-free cinnamon lattes with medium foam (and, of course, no hydrogenated palm oil). It costs $4,000 if purchased today, is expected to last four years, and will generate net cash flows of $1,200 for each of the four years. Assume that the cash inflows occur at the end of each year.

A) If the discount rate is 10%, what is the net present value of this investment? Show your work.

B) Does the decline in the discount rate cause a change in the quantity demanded of the coffee machine or a change in demand? Briefly explain.

C) What is the relation between Net Present Value (NPV) and economic profit? Explain in three sentences or fewer.

Answer 1

A) If the discount rate is 10% then NPV will be:

years	Amount	PVF	PV
0	-4,000.00	1.00	(4,000.00)
1	1,200.00	0.90909	1,090.91
2	1,200.00	0.82645	991.74
3	1,200.00	0.75131	901.58
4	1,200.00	0.68301	819.62
		NPV	(196.16)

B) Discount rate can be understood as the rate on which future cash flow could be invested/re-invested to generate cash flow. since the rate of investment(other than coffee machine) in future is declining, investment in machine is automatically favourable for investment. It can be shown as follow:

years	Amount	PVF(10%)	PV	PVF(8%)	PV	PVF(5%)	PV
0	-4,000.00	1.00	(4,000.00)	1	-4000	1	-4000
1	1,200.00	0.90909	1,090.91	0.925926	1111.111	0.952381	1142.857
2	1,200.00	0.82645	991.74	0.857339	1028.807	0.907029	1088.435
3	1,200.00	0.75131	901.58	0.793832	952.5987	0.863838	1036.605
4	1,200.00	0.68301	819.62	0.73503	882.0358	0.822702	987.243
		NPV	(196.16)		(25.45)		255.14

    C) Economic Profit (EVA) is empahsizes on earning capacity of the company in future comparable to NPV is only the PV of future cash flow of the given project.

EVA consider accounting period data and sum them up, on the other hand NPV consider Non accounting period data it consider duration of project in question.

An important distinction between these two is EVA consider accounting data whereas NPV approach is based on market value.