Joanette, Inc., is considering the purchase of a machine that would cost $570,000 and would last for 9 years, at the end of which, the machine would have a salvage value of $57,000. The machine would reduce labor and other costs by $117,000 per year. Additional working capital of $3,000 would be needed immediately, all of which would be recovered at the end of 9 years. The company requires a minimum pretax return of 18% on all investment projects. (Ignore income taxes.) Determine the net present value of the project.

Question

Serenity Carlson

Business

14 September, 02:10

Joanette, Inc., is considering the purchase of a machine that would cost $570,000 and would last for 9 years, at the end of which, the machine would have a salvage value of $57,000. The machine would reduce labor and other costs by $117,000 per year. Additional working capital of $3,000 would be needed immediately, all of which would be recovered at the end of 9 years. The company requires a minimum pretax return of 18% on all investment projects. (Ignore income taxes.) Determine the net present value of the project.

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Harper Everett · Answer 1

The NPV of the project is - $68,870

Explanation:

- We have the cash flows from the investment and its timing as listed below:

+ Year 0 : - (Initial Machine investment cost + working capital) = - $573,000;

+ Year 1 - Year 8, each year: Labor and other cost reduction = $117,000;

+ Year 9: Labor and other cost reduction + Working capital recovery = 117,000 + 3,000 = $120,000.

- Thus, net present value of the project is all the above cash flows discounted at required rate of return 18%, calculated as followed:

-573,000 + [ (117,000/0.18) / (1 - 1.18^-8) ] + (120,000/1.18^9) = - $68,870.

- So, the answer is NPV of the project is - $68,870.