Problem - Lorenzo Company is considering the purchase of equipment with an eight year life that requires a $1,600,000 investment. At the end of eight years, the equipment will have no salvage value. For eight years, the equipment will provide net income at the end of each year as follows:
Sales - $3,000,000
Less: Variable Expenses - 1,800,000
Contribution margin - 1,200,000
Less: Fixed Expenses:
Advertising - 700,000
Depreciation on equipment - 200,000
Net income - $300,000
Other information follows:
Required rate of return - 18%
Depreciation method for tax purposes - Straight-line
Present value of ordinary annuity of one at 18% for 8 periods - 4.0776
Present value of one at 18% for 8 periods - 0.266
Required:
1. Compute annual cash flows generated by the equipment.
2. Compute the equipment's net present value.
3. If the salvage value of the equipment is $10,000, compute the equipment's net present value.