A $130,000 investment in new equipment this year will increase your firm's profits by $50,000 in each of the next 3 years. What is the net present value of this investment if your firm's opportunity cost of capital is 10 percent?

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by discounting the future cash flows back to their present value and then subtracting the initial investment. The formula for NPV is: NPV = (Cash Flow / (1 + r)^t) - Initial Investment, where r is the discount rate (opportunity cost of capital) and t is the time period. For this investment, the cash flows are $50,000 for each of the next 3 years, and the discount rate is 10% (0.10). Year 1: $50,000 / (1 + 0.10)^1 = $45,454.55Year 2: $50,000 / (1 + 0.10)^2 = $41,322.31Year 3: $50,000 / (1 + 0.10)^3 = $37,565.74Total NPV = $45,454.55 + $41,322.31 + $37,565.74 - $130,000 = $124,342.60 - $130,000 = -$5,657.40Rounded to the nearest whole number, the NPV is approximately -$5,657, which matches choice A.

A $130,000 Investment in New Equipment This Year Will Increase