Net Present Value/Present Value Index

Topics: Net present value, Variable cost, Cash flow, Costs, Investment, Internal rate of return / Pages: 11 (2574 words) / Published: Apr 16th, 2013
Net Present Value/Present Value Index The management team at Savage Corporation is evaluating two alternative capital investment opportunities. The first alternative, modernizing the company’s current machinery, costs $45,000. Management estimates the modernization project will reduce annual net cash outflows by $12,500 per year for the next five years. The second alternative, purchasing a new machine, costs $56,500. The new machine is expected to have a five-year useful life and a $4,000 salvage value.
Management estimates the new machine will generate cash inflows of $15,000 per year. Savage’s cost of capital is 10%. Required
a. Determine the present value of the cash flow savings expected from the modernization program.
Using the data from Appendix on page 1169 of our text 15000*3.790787 = 47,385, which should be the PV cash flow savings expected from the first option of modernization program. b. Determine the net present value of the modernization project.
I believe the NPV of the 1st project is calculated by subtracting current machinery, costs $45,000 from the figure above which equals 2,385.00
c. Determine the net present value of investing in the new machine.
This is determined by valuing the future cash flows. Using the same appendix in table 2 data, annual cash flow of 15,000 * 3.790787 =56862.00 Salvage cost of 4,000 * .620921 (table 3 on page 523) = 2484.00 Total=59,346.00 less the cost of machinery 56,500 = 2486.00 as the NPV
d. Use a present value index to determine which investment alternative will yield the higher rate of return.
PI= $15,000*.620921/56,500 = .16
This investment is not acceptable because it has a PI of less than 1.0 therefore the modernization project or the first alternative will have higher rate of return.

Exercise 24-4A Determining the present value of an annuity

The dean of the School of Social Science is trying to decide whether to purchase a copy machine to place in

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