Avionics Corp. is considering the purchase of a new machine for $76,000. The machine would generate an annual cash flow of $23,214 per year for five years. At the end of five years, the machine would have no salvage value. The company's cost of capital is 12 percent. The company uses straight-line depreciation with no mid-year convention. What is the net present value for the machine, assuming no taxes are paid?

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) of the machine, we need to discount the cash flows back to their present value at the company's cost of capital. Using the straight-line method, the annual depreciation expense is ($76,000 / 5) = $15,200. Therefore, the annual after-tax cash flow is ($23,214 - $15,200) = $8,014. The table below shows the calculation of the NPV:

Year  |  Cash flow |  PV factor (12%)  |  Discounted cash flow 
1          $8,014           .893           $7,166
2          $8,014           .797           $6,397
3          $8,014           .712           $5,703
4          $8,014           .636           $5,097
5          $8,014           .567           $4,540
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Total NPV                                                     $7,686

Since the NPV is positive, the machine should be purchased.