ABC Company is considering the purchase of a new machine for $76,000. The machin
ID: 2557756 • Letter: A
Question
ABC Company is considering the purchase of a new machine for $76,000. The machine would generate a net cash inflow of $23,214 per year for 5 years. At the end of 5 years, the machine would have no salvage value. The company's cost of capital is 12 percent. The company uses straight-line depreciation. The present value factors of annuity of $1.00 for different rates of return are as follows: Year 4 5 6 12% 3.037 3.605 14% 2.914 3.433 3.889 16% 2.798 3.274 3.685 18% 2.690 3.127 3.498 What is the net present value of the investment? a. $6,987.70 b. $6,098.77 c. $10,691.18 d. $7,686.47 1. A company invests in a project that realizes an internal rate of return equal to its cost of capital. The project should a. Increase the value of the company. b. Have little or no effect on the value of the company c. Decrease the value of the company d. Cause the company to realize an infinite net present value.Explanation / Answer
Total present value of net cash inflow = Net cash inflow per year for 5 year × PV annuity factor of year 5 at 12% = $23,214 × 3.605 =$83,686.47
Net present value of the investment = Total present value of net cash inflow - Present value of cash outflow
= $83,686.47 - $76,000
= $7,686.47
Hence, the correct answer is option d. $7,686.47
1.
Ans: b. Have little or no effect on the value of the company.
Justification:
In general, IRR (Internal rate of return) should be greater than cost of capital, to pursue the project, and it will increase the value of the company. But, if IRR lesser than cost of capital, then the project will decrease the value of the company.
But, in this case IRR is equal to the cost of capital. Hence, this project should have little or no effect on the value of the company.