A machine has a cost of $5,575,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, the project should be
A) accepted.
B) rejected.
C) discounted at a lower rate.
D) abandoned after the first year.

Question

Quizplus · Accepted Answer

To determine whether the machine is worth the investment, we need to calculate the present value of the expected cash inflows and compare it to the cost of the machine. Using a discount rate of 16.25%, the present value of the cash inflows is:

PV = $1,825,000/(1+0.1625) + $1,775,000/(1+0.1625)^2 + $1,630,000/(1+0.1625)^3 + $1,585,000/(1+0.1625)^4 + $1,650,000/(1+0.1625)^5
PV = $1,825,000/1.1625 + $1,775,000/1.3476 + $1,630,000/1.5608 + $1,585,000/1.8085 + $1,650,000/2.0911
PV = $1,570,303 + $1,316,074 + $1,044,788 + $877,080 + $789,417
PV = $5,597,662

The present value of the expected cash inflows is greater than the cost of the machine ($5,597,662 > $5,575,000). Therefore, the project should be accepted.

Note: Option C is not a valid choice since the discount rate used is already higher than the company's required rate of return.

A Machine Has a Cost of $5,575,000