Question 1: Net Present Value Analysis. Heston Farming Company would like to purchase a harvesting machine for $100,000. The machine is expected to have a life of 4 years, and a salvage value of $20,000. Annual maintenance costs will total $28,000. Annual savings are predicted to be $60,000. The companyâs required rate of return is 11 percent.
Required:
a.) Ignoring the time value of money, calculate the net cash inflow or outflow resulting from this investment opportunity.
b.) Find the net present value of this investment using the format presented in Figure 8.2 "NPV Calculation for Copy Machine Investment by Jacksonâs Quality Copies". Round to the nearest dollar.
c.) Should the company purchase the harvesting machine? Explain.
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Timeline (n)
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Today
0
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Year
1
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Year
2
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Year
3
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Year
4
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Year
5
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Year
6
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Year
7
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Purchase price
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5(50,000)
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Maintenance cost
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S (1,000)
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$ (1,000)
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S (1,000)
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(1,000)
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(1,000)
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$ (1,000)
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$ (1,000)
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Labor savings
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11,000
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11,000
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11,000
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11,000
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11,000
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11,000
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11,000
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Salvage value
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5,000
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Total cash in (out)
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$(50,000)
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$ 10,000
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$ 10,000
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$ 10,000
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$ 10,000
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$ 10,000
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S 10,000
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$ 15,000
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PV factor (r = 10%)
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x 1.0000
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x 0.9091
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x 0.8264
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x 0.7513
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x 0.6830
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x 0.6209
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x 0.5645
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x 0.5132
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Present value
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S(50,000)+
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S 9,091
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+
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5 8,264
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+
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S 7,513
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+
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6,830
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+
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$ 6,209
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+
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S 5,645
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+
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7,698
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=
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$ 1,250
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Figure 8.2 NPV Calculation for Copy Machine Investment by Jackson's Quality Copies
The NPV is $1,250. Because NPV is > o, accept the investment. (The investment provides a return greater than io percent.)
Question 2: Internal Rate of Return Analysis. Heston Farming Company would like to purchase a harvesting machine for $100,000. The machine is expected to have a life of 4 years, and a salvage value of $20,000. Annual maintenance costs will total $28,000. Annual savings are predicted to be $60,000. The companyâs required rate of return is 11 percent (this is the same data as the previous exercise).
Required:
a.) Use trial and error to approximate the internal rate of return for this investment proposal.
b.) Should the company purchase the harvesting machine? Explain.
Question 3: Payback Period Calculation. Heston Farming Company would like to purchase a harvesting machine for $100,000. The machine is expected to have a life of 4 years, and a salvage value of $20,000. Annual maintenance costs will total $28,000. Annual savings are predicted to be $60,000 (this is the same data as the previous exercise). Determine the payback period for this investment using the format shown in Table 8.1 " Calculating the Payback Period for Jacksonâs Quality Copies".
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Investment (Cash Outflow)
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Cash Inflow
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Unrecovered Investment Balance
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Year 0
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$(50,000)
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$(50,000)a
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Year 1
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$10,000
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(40,000)b
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Year 2
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10,000
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(30,000)c
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Year 3
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10,000
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(20,000)
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Year 4
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10,000
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(10,000)
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Year 5
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10,000
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0
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Year 6
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10,000
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0
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Year 7
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15,000
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0
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$(50,000) = $(50,000) initial investment.
$(40,000) = $(50,000) unrecovered investment balance + $10,000 year 1 cash inflow.
$(30,000) = $(40,000) unrecovered investment balance at end of year 1 + $10,000 year 2 cash inflow.