Wilson Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $50,000. The equipment will have an initial cost of $600,000 and have an 8-year life. The salvage value of the equipment is estimated to be $100,000. If the hurdle rate is 10%, what is the approximate net present value?

Question

Quizplus · Accepted Answer

First, calculate the annual cash flows: 
Net income increase = $50,000
Depreciation = ($600,000 - $100,000) / 8 = $62,500
Annual cash flows = $50,000 + $62,500 = $112,500

Next, calculate the present value of each cash flow using a discount rate of 10%:

PV of cash flow year 1-7 = $112,500 / (1 + 0.10)^1 + $112,500 / (1 + 0.10)^2 + ... + $112,500 / (1 + 0.10)^7 = $580,174.96

PV of cash flow year 8 (including salvage value) = ($112,500 + $100,000) / (1 + 0.10)^8 = $128,322.85

The NPV is then calculated as the sum of the present values of all cash flows minus the initial cost:

NPV = $580,174.96 + $128,322.85 - $600,000 = $108,497.81

This means the project is expected to generate a net present value of $108,497.81, which is greater than zero and therefore, should be accepted.