Use the following information to answer the next two questions. The Slick Hotel is appraising the merit of a proposed investment in a vending machine with an eight year life. The investment will require an initial outlay of $22,000 and provide increased cash inflows of $24,000 per annum and generate increased cash outflows of $20,000 per annum. The vending machine will be sold off for $3,000 in eight year's time.
-Assuming a 6% cost of capital, what is the net present value of the Slick Hotel vending machine investment?

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV), we need to find the present value of all cash inflows and outflows. Using a 6% cost of capital, we can calculate the present value of each cash flow as follows:

Year 0: -$22,000 initial outlay
Year 1: $24,000 cash inflow, present value = $22,642.86
Year 1: -$20,000 cash outflow, present value = -$18,867.92
Year 2: $24,000 cash inflow, present value = $21,350.09
Year 2: -$20,000 cash outflow, present value = -$17,793.92
Year 3: $24,000 cash inflow, present value = $20,091.14
Year 3: -$20,000 cash outflow, present value = -$16,770.55
Year 4: $24,000 cash inflow, present value = $18,855.93
Year 4: -$20,000 cash outflow, present value = -$15,820.75
Year 5: $24,000 cash inflow, present value = $17,643.93
Year 5: -$20,000 cash outflow, present value = -$14,938.61
Year 6: $24,000 cash inflow, present value = $16,454.67
Year 6: -$20,000 cash outflow, present value = -$14,208.91
Year 7: $24,000 cash inflow, present value = $15,287.71
Year 7: -$20,000 cash outflow, present value = -$13,530.67
Year 8: $24,000 cash inflow + $3,000 salvage value, present value = $17,278.11

To find the NPV, we add up all the present values and subtract the initial outlay:

NPV = $22,642.86 - $18,867.92 + $21,350.09 - $17,793.92 + $20,091.14 - $16,770.55 + $18,855.93 - $15,820.75 + $17,643.93 - $14,938.61 + $16,454.67 - $14,208.91 + $15,287.71 - $13,530.67 + $17,278.11 - $22,000
NPV = $47,280.38 - $22,000
NPV = $25,280.38

Since the NPV is positive, the investment is expected to generate a return higher than the cost of capital and therefore it is a good investment. Choices A, B, D and E are incorrect because they are not the correct calculation of the NPV.

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