Use the following information to answer the next two questions: A manufacturing
ID: 1167506 • Letter: U
Question
Use the following information to answer the next two questions:
A manufacturing firm is deciding whether to invest in a new printer that needs an initial investment of $150,000. This will increase cash flows in the first year by $80,000 and $75,000 in the second year.
If the cost of capital decreased to 1%, does the firm invest in the new technology?
Yes because the NPV=0
Yes because the NPV>0
No because the NPV<0
Need information on the marginal benefits and costs
a.Yes because the NPV=0
b.Yes because the NPV>0
c.No because the NPV<0
d.Need information on the marginal benefits and costs
Explanation / Answer
The factor of cost of capital at 1% rate in each would be as below:
1st year = 1 / (1 + 0.01)^1 = 0.9901
2nd year = 1 / (1 + 0.01)^2 = 0.9803
Net present value (NPV): This is the difference between present value of future cash flows and the initial investments. The project should be accepted if NPV > 0.
NPV = {($80,000 × 0.9901) + ($75,000 × 0.9803)} - $150,000
= ($79,208 + $73,522.5) - $150,000
= $152,730.5 - $150,000
= $2,730.5
Since NPV is greater than 0, the firm should invest in the new technology.
Answer: The correct option is b.