Company Abc Needs a Machine for Its Manufacturing Process

Company ABC needs a machine for its manufacturing process.

• The cost of the new machine is $80,700.

• The expected useful life of the machine is 8 years.

• At the end of 8-year period, the machine would have no salvage value.

• After installation, the machine would increase cash inflows by $30,000 per year.

• Calculate the NPV and IRR of the machine.

• The minimum required rate of return of the company is 12% on all capital investments.

• The cost of capital is 8%.

• Would you accept or reject this investment?

Answer

Year Cash Out Cash In (Savings) Discount Factor Discounted Cash Out Discounted Cash In (Savings)

0 $ 80,700.00 $ (80,700.00) 1 $80,700.00 0

1 $0.00 $30,000.00 1.12 $0.00 $ 26,785.71

2 $0.00 $30,000.00 1.254 $0.00 $ 23,915.82

3 $0.00 $30,000.00 1.405 $0.00 $ 21,353.41

4 $0.00 $30,000.00 1.574 $0.00 $ 19,065.54

5 $0.00 $30,000.00 1.762 $0.00 $ 17,022.81

6 $0.00 $30,000.00 1.974 $0.00 $ 15,198.93

7 $0.00 $30,000.00 2.211 $0.00 $ 13,570.48

8 $0.00 $30,000.00 2.476 $0.00 $ 12,116.50

Total $80,700.00 $149,029.19

NPV $ 68,329.19

IRR 33%

Based on the calculation, accept the investment

• What are the advantages and disadvantages of NPV and IRR?

Advantages Disadvantages

• Straight forward to calculate.

• Widely used analytical tool, used to compare similar alternatives.

• Rely on assumptions and estimates, more room for errors.

• Does not account for unforeseen expenditures.

• Assume constant discount rate overtime, even in real life it may change.

• IRR assumes that all cash flows received from the project are reinvested at the same rate of return

Company ABC needs a machine for its manufacturing process.