You are the manager of a local factory that produces plastic bottles for soft drink manufacturers. Your assistant comes to you with exciting news about a new assembly line for the company. He presents the following data to you that he’s researched:
Estimated life of assembly line: 4 years
Initial investment cost: $800,000
Estimated salvage value: none
Estimated Cash Flow Analysis
Year Expected Cash Flow
1 $450,000
2 240,000
3 150,000
4 60,000
a) If the current interest rate is 3 percent, use net present value analysis to determine whether or not the company should purchase this new machine.
b) Ceteris paribus, what is the relationship between the interest rate and the present value of a given amount of money? What does “present value” even mean?
a)
Present value = (Future value * Present value factor)
Present value factor = 1 / ( 1 + r ) 1 + 1 / ( 1 + r )2 ...........1/ ( 1 + r )n
| Year | Expected cash flow | Present value factor @3% | Present value |
| 1 | 450000 | 0.971 | 436950 |
| 2 | 240000 | 0.943 | 226320 |
| 3 | 150000 | 0.915 | 137250 |
| 4 | 60000 | 0.888 | 53280 |
| Total present value | 853800 | ||
Net present value = Total present value - Initial investment
= $853800 - $800000
= $53800
Decision:- Company should purchase the machine as it gives positive net present value.
b)
Interest rate is the required return which an investor wants on its investment. Higher interest rate means investor wants higher return form the investment and vice- versa. If interest rate increases then present value of future benefits will decreases. Since Less amount is required today to gain the given amount in future with higher interest rate. money will grow faster with higher interest rate.
If interest rate is lower then present value is higher . It means due to lower desire return of the investor money will not grow that faster and we need higher present value today to gain the given future value.
Present value :- It shows value of all the future cash flows in today's term. It is calculated by discounting the future cash flows with the desire rate of return of the investors.
You are the manager of a local factory that produces plastic bottles for soft drink manufacturers. Your assistant comes to you with exciting news about a new assembly line for the company. He presents...
You are the manager of a local factory that produces plastic bottles for soft drink manufacturers. Your assistant comes to you with exciting news about a new assembly line for the company. He presents the following data to you that he’s researched: Estimated life of assembly line: 4 years Initial investment cost: $800,000 Estimated salvage value: none Estimated Cash Flow Analysis Year Expected Cash Flow 1 $450,000 2 240,000 3 150,000 4 ...
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...
Amy Cola is considering launching a new soft drink product. The beverage will be sold in a variety of different flavors and will be marketed to young adult. In evaluating the proposed project, the company has the following information: • The project is estimated to last for 4 years and will have a debt ratio for 10%. • The company will need to purchase new machinery that has an up-front cost of $40 million (incurred at Year 0). The machinery...