Reference no: EM1312279

Selection of Purchase alternatives under NPV.

Prince Company's required rate of return is 10%. The company is considering the purchase of three machines, as indicated below. Consider each machine independently.

Required:

a. Machine A will cost $25,000 and have a life of 15 years. Its salvage value will be $1,000, and cost savings are projected at $3,500 per year. Compute the machine's net present value.

b. How much will Prince Company be willing to pay for Machine B if the machine promises annual cash inflows of $5,000 per year for 8 years?

c. Machine C has a projected life of 10 years. What is the machine's internal rate of return, to the nearest whole percent, if it costs $30,000 and will save $6,000 annually in cash operating costs? Would you recommend purchase? Explain. 

$1,860

a		Year	Amount	10% Factor	Present Value
	Investment required	now	($25,000)	1	($25,000)
	Annual cost savings	1-15	$3,500	7.606	26,621
	Salvage value	15	$1,000	0.239	239
	Net present value				$1,860
b		Year	Amount	10% Factor	Present Value
	Annual cash inflows	1-8	$5,000	5.335	$26,675

 
Since the present value of the cash inflows is $26,675, the company should be willing to pay up to this amount to acquire the machine.

c. Investment required + Net annual cash flow = Factor of the internal rate of return
$30,000 + $6,000 = 5.000
To the nearest whole percent, the internal rate of return is 15%.

The machine should be purchased, since the internal rate of return is greater than the required rate of return.