Suppose a manager of a firm is considering investing in a piece of equipment that will generate $20,000 in future operating profit each year for the next three years. The discount rate is 5 percent and the salvage value of zero. The equipment's current cost is $50,000 and this cost will be financed by the firm. If the tax rate on the firm's profit is 4 percent each year, what is the net present value of the equipment?
A)- $2,581
B)$2,286
C)$3,569
D)$4,464

Question

Quizplus · Accepted Answer

To find the net present value (NPV), we need to calculate the present value of each year's operating profit and then subtract the initial cost of the equipment.

First, let's calculate the present value factor using the discount rate and number of years:
PVF = 1 / (1+r)^n
PVF = 1 / (1+0.05)^1 = 0.9524
PVF = 1 / (1+0.05)^2 = 0.9070
PVF = 1 / (1+0.05)^3 = 0.8638

Next, we can calculate the present value of each year's operating profit:
Year 1: $20,000 x 0.96 / (1+0.05)^1 = $19,047
Year 2: $20,000 x 0.96 / (1+0.05)^2 = $17,750
Year 3: $20,000 x 0.96 / (1+0.05)^3 = $16,423

Now, we can calculate the NPV by subtracting the initial cost from the sum of the present values:
NPV = -$50,000 + $19,047 + $17,750 + $16,423
NPV = -$50,000 + $53,220
NPV = $3,220

Since the NPV is positive, the investment is expected to generate a return greater than the required rate of return (5%), so it would be a good investment. Choice B is the correct answer.

Suppose a Manager of a Firm Is Considering Investing in a Piece