The Orgonne Milling Company is contemplating the purchase of new equipment. The machinery is expected to generate increased sales of $50 000 per year over its five-year life. Excluding the cost of the machinery, additional costs are expected to be $15 000 per year. If the firm requires a minimum 12% return on its investment, what is the maximum price the company can pay for this equipment? (PV annuity at 12% for five years is 3.604)

Question

Quizplus · Accepted Answer

To calculate the maximum price the company can pay for the equipment, we need to find the present value of the cash inflows (sales) and outflows (additional costs) over the five-year life of the machinery.

PV of additional costs over five years at 12% = $15 000 x (PV annuity factor for 5 years at 12%) = $15 000 x 3.604 = $54 072

PV of cash inflows (sales) over five years at 12% = $50 000 x (PV annuity factor for 5 years at 12%) = $50 000 x 3.604 = $180 200

Net present value (NPV) of cash inflows and outflows over five years at 12% = PV of cash inflows - PV of additional costs = $180 200 - $54 072 = $126 140

Therefore, the maximum price the company can pay for the equipment is $126 140, which is the net present value of the cash inflows and outflows over the five-year life of the machinery, discounted at the minimum required rate of return of 12%.

Option C is the correct choice.

The Orgonne Milling Company Is Contemplating the Purchase of New