A cloth manufacturing firm is deciding whether or not to invest in new machinery.The machinery costs $45,000 and is expected to increase cash flows in the first year by $25,000 and in the second year by $30,000.The firm's current fixed costs are $9,000 and current marginal costs are $15.The firm currently charges $18 per unit.If the interest rate is 5% then the present value of the cash flows is
A)$6,020.41
B)$51,020.41
C)-$7,380.95
D)$10,000

Question

​A cloth manufacturing firm is deciding whether or not to invest in new machinery.The machinery costs $45,000 and is expected to increase cash flows in the first year by $25,000 and in the second year by $30,000.The firm's current fixed costs are $9,000 and current marginal costs are $15.The firm currently charges $18 per unit.If the interest rate is 5% then the present value of the cash flows is
A)​$6,020.41
B)$51,020.41
C)-$7,380.95
D)​$10,000

Quizplus · Accepted Answer

The present value calculation is as follows:

PV = (25,000/(1+0.05)^1) + (30,000/(1+0.05)^2) - 45,000

PV = 23,809.52 + 26,210.89 - 45,000

PV = $4,020.41

Since the present value of the cash flows is positive, the investment is profitable. Therefore, the best choice is to invest in the new machinery. The present value of the cash flows is $51,020.41, which is greater than the cost of the machinery.

​A Cloth Manufacturing Firm Is Deciding Whether or Not to Invest

A Cloth Manufacturing Firm Is Deciding Whether or Not to Invest