Natick Products is evaluating an investment in new production machinery. The initial investment is $700,000 and will yield cash flows of $120,000 per year for an 8 year period. At the end of 8 years, the machinery will be sold and has expected residual value of $90,000. Natick uses a discount rate of 6%. What is the net present value of the investment?

Question

Quizplus · Accepted Answer

To calculate the net present value, we need to discount all the cash flows to their present value, then subtract the initial investment. The annual cash flow of $120,000 is an annuity, so we can use the annuity formula:

PV = C x ((1 - (1 / (1 + r)^n)) / r)

where PV is the present value, C is the annual cash flow, r is the discount rate, and n is the number of years. Plugging in the values, we get:

PV = $120,000 x ((1 - (1 / (1 + 0.06)^8)) / 0.06)
PV = $731,386.68

Next, we need to discount the residual value of $90,000 back to its present value. Since it occurs at the end of year 8, we can simply use the present value formula:

PV = FV / (1 + r)^n
PV = $90,000 / (1 + 0.06)^8
PV = $54,041.33

Now we can calculate the net present value:

NPV = PV of cash flows - Initial investment
NPV = ($120,000 x ((1 - (1 / (1 + 0.06)^8)) / 0.06)) + ($54,041.33) - ($700,000)
NPV = $101,630.01

Therefore, the best choice is C, with an NPV of $101,630.

Natick Products Is Evaluating an Investment in New Production Machinery