Figure 6
JD, Inc., is considering the purchase of production equipment that costs £400,000. The equipment is expected to generate annual cash inflows of £125,000. The equipment is expected to have a useful life of five years with no salvage value. The firm's cost of capital is 12 percent.
-Refer to Figure 6. JD's net present value of the project is

Question

Quizplus · Accepted Answer

Net present value (NPV) can be calculated as:
NPV = Present value of cash inflows - Present value of cash outflows

In this case, the cash inflows are £125,000 per year for 5 years, discounted at a rate of 12% using the present value of an annuity formula:

PV of cash inflows = £125,000 x (1 - 1/ (1+0.12)^5) / 0.12
PV of cash inflows = £450,375

The cash outflow is the initial cost of the equipment, £400,000. Therefore, the NPV can be calculated as:

NPV = £450,375 - £400,000
NPV = £50,375

Since the NPV is positive, JD should invest in the project as it is expected to generate value for the firm. Therefore, the best choice is C.

Figure 6 JD, Inc., Is Considering the Purchase of Production Equipment That