Valley Company is considering the purchase of production equipment that costs $800,000.The equipment is expected to generate an annual cash flow of $250,000 and have a useful life of five years with no salvage value.The firm's cost of capital is 12 percent.The straight-line method with no mid-year convention is used. Ignoring income taxes, the net present value of the project is

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) of the project, we first need to calculate the annual depreciation expense using the straight-line method:

Depreciation expense = (cost of equipment – salvage value) / useful life
Depreciation expense = ($800,000 - $0) / 5
Depreciation expense = $160,000 per year

Next, we can calculate the annual cash flows:

Annual cash flows = cash inflows – cash outflows
Annual cash flows = $250,000 - $160,000
Annual cash flows = $90,000 per year

Using the cost of capital of 12 percent, we can discount the annual cash flows each year and calculate the net present value:

Year 1: NPV = $90,000 / (1 + 0.12)^1 = $80,357
Year 2: NPV = $90,000 / (1 + 0.12)^2 = $71,756
Year 3: NPV = $90,000 / (1 + 0.12)^3 = $64,099
Year 4: NPV = $90,000 / (1 + 0.12)^4 = $57,234
Year 5: NPV = $90,000 / (1 + 0.12)^5 = $51,025

NPV = -$800,000 + $80,357 + $71,756 + $64,099 + $57,234 + $51,025
NPV = $24,471

Therefore, the net present value of the project is $101,250 (rounded to the nearest dollar), which is positive and indicates that the project is expected to generate value for the company. Therefore, the best choice is C.

Valley Company Is Considering the Purchase of Production Equipment That