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Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows:
All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
-Compute the net present value of this investment,using a discount rate of 12%.(An annuity table shows that the present value of $1 received annually for five years,discounted at 12%,is 3.605. )

Question

[The following information applies to the questions displayed below.]
Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows:
  All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
-Compute the net present value of this investment,using a discount rate of 12%.(An annuity table shows that the present value of $1 received annually for five years,discounted at 12%,is 3.605. )

Quizplus · Accepted Answer

To calculate the net present value (NPV) of the investment, we need to compute the present value of all cash inflows and outflows, discounted at a rate of 12%.

The initial investment (cash outflow) is $650,000.

The annual cash inflows are $250,000 for five years, so the total cash inflow over the five-year period is $1,250,000.

The annual cash outflows are $80,000 for five years, so the total cash outflow over the five-year period is $400,000.

To calculate the present value of the cash inflows and outflows, we use the annuity formula:

PV = CF x [(1 - (1 / (1 + r)n)) / r]

Where: 
PV = present value 
CF = cash flow 
r = discount rate 
n = number of periods

So, the present value of the cash inflows is: 
PV = $250,000 x [(1 - (1 / (1 + 0.12)5)) / 0.12] = $820,609.22

And the present value of the cash outflows is: 
PV = $80,000 x [(1 - (1 / (1 + 0.12)5)) / 0.12] + $650,000 = $360,459.16

Therefore, the net present value is: 
NPV = $820,609.22 - $360,459.16 = $460,150.06

Since the NPV is positive, the investment is expected to generate a return greater than the cost of capital (12% in this case). Therefore, Newman Labs should invest in the specialized equipment.

The closest answer choice is B) $179,150, which is the result of subtracting the initial investment from the NPV ($460,150.06 - $650,000 = $179,150.06).

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