Question

EMiNAR Co. has an opportunity to purchase an $86,000 piece of equipment. EMiNAR wants to determine if the equipment should be purchased using the following information:

• The equipment will create a positive cash flow of $18,500 per year.
• The equipment will have a six-year life.
• The equipment will have a salvage value of $5,000 at the end of its life.
• EMiNAR has a 10% cost of capital.
• Income taxes are ignored when evaluating investments.

(a.) What is the net present value of the equipment purchase? Round the answer to the nearest $1.

(b.) Determine if the internal rate of return is higher, lower or equal to EMiNAR’s cost of capital. Explain why the internal rate of return is higher, lower or equal.

Answer 1

3 ear Initial purchase cost of the piece of e Yearly cash flows Salvage value of the e Net cash flows (Sum of IRR Present value factors@ 10% Present value of cash flows Net present value $86,000.00 $18,500.00 |S18,500.00 S18,500.00 S18,500.00 |S18,500.00 S18,500.00 $5,000.00 ($86,000.00) S18,500.00 |S18,500.00 $18,500.00 |S18,500.00 S18,500.00 |S23,500.00 cash flows 990 $1.00 S0.56 ($86,000.00) S16,818.18 |S15,289.26 S13,899.32 |S12,635.75S11,487.04 |S13,265.14 $0.91 S0.68 S0.83 S0.75 S0.62 (S2,605.31) IRR Formula (Add'' before formula) NPV formula (Add''before formula) IRR(H110N110) SUM(H113-N113) NPV of the equipment purchase is (S2,605.31) Internal rate of return is lower than the Neiman's cost of capital. Internal rate of return on a project should be higher than the minimum required rate of return (Cost of capital). It means returns we are earning from investment of funds borrowed shall reach at least that cost of borrowings. That's why if IRR is higher than the cost of capital then only we can go ahead with that project.