Answer the following questions using the information below:
Cronulla Cleaners is considering the purchase of an industrial dry-cleaning machine.The existing machine is operable for three more years and will have a zero disposal price.The machine may be sold for $50 000 now.The new machine will cost $200 000 and an additional cash investment in working capital of $50 000 will be required.The new machine will reduce the average time required to wash clothing and will decrease labour costs.The investment is expected to net $45 000 in additional cash inflows during the year of acquisition and $135 000 each additional year of use.The new machine has a three-year life,and zero disposal value.These cash flows will occur throughout the year but will be recognised at the end of each year.Income taxes are not considered in this problem.The working capital investment will not be recovered at the end of the asset's life.
-What is the net present value of the investment,assuming the required rate of return is 24%? Would the company want to purchase the new machine?

Question

Quizplus · Accepted Answer

The net present value (NPV) of the investment is calculated by subtracting the initial investment from the present value of the cash inflows. The initial investment includes the cost of the new machine ($200,000) and the additional working capital ($50,000), but we also need to consider the $50,000 that can be obtained from selling the existing machine now. Thus, the total initial outlay is $200,000 + $50,000 - $50,000 = $200,000. The cash inflows are $45,000 in the first year and $135,000 for the next two years. Using a discount rate of 24%, the present value of these cash inflows can be calculated and then subtracted from the initial investment to find the NPV. Given the negative NPV and the decision rule of NPV (where a positive NPV indicates a good investment), the company would not want to purchase the new machine.

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