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Using discounted cash flow models to make capital investment decisions
Sprocket Industries is deciding whether to automate one phase of its production process. The manufacturing equipment has a six-year life and will cost $905,000. Projected net cash inflows are as follows:
Year 1
$260,000
Year 2
$254,000
Year 3
$225,000
Year 4
$215,000
Year 5
$205,000
Year 6
$173,000
Requirements
1. Compute this project's NPV using Sprocket's 16% hurdle rate. Should Sprocket invest in the equipment?
2. Sprocket could refurbish the equipment at the end of six years for $103,000. The refurbished equipment could be used one more year, providing $75,000 of net cash inflows in year 7. Additionally, the refurbished equipment would have a $54,000 residual value at the end of year 7. Should Sprocket invest in the equipment and refurbishing it after six years?
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