Cowboy Recording Studio is considering the investment of $132,200 in a new recor

Question

Cowboy Recording Studio is considering the investment of $132,200 in a new recording equipment. It is estimated that the new equipment will generate additional cash flow of $19,500 per year for each year of its 7-year life and will have a salvage value of $14,500 at the end of its life. Cowboys's financial managers estimate that the firm's cost of capital is 8%. Use Table 6-4 and Table 6-5. (Use appropriate factor(s) from the tables provided. Round the PV factors to 4 decimals.) Required: a. Calculate the net present value of the investment. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations.) Net present value b. Calculate the present value ratio of the investment. (Round your answer to 2 decimal places.) Present value rat io c. What is the internal rate of return of this investment, relative to the cost of capital? internal rate of retum of this investment is less than the cost of capital of 8%. d. Calculate the payback period of the investment. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Payback period

Explanation / Answer

Ans a. Present value of the investment is as under:-

Present value = Present value(Benefits) - Present value(costs)

Discount rate = 8%

Cash flow per year = $19,500

Time period = 7 years

Salvage value = $14,500

So lets calculate the present value of benefits

Present value of benefits = cash flow per year*(Annuity present value) + salvage value*1/(1+8%)^7

Present value of benefits = $19500(5.2064) + $14500*0.5835 = $101524.80 + $8460.75

Present value of benefits = $109,985.55

Present value of cost = $132,200

Net present value = $109,985.55 - $132,200 = -$22,214.45.

So its a negative NPV for the cowboy recording studio.

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