Question

The management of California Corporation is considering the purchase of a new machine costing $400,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability of this investment: Year Income from Operations Net Cash Flow 1 $100,000 $180,000 2 40,000 120,000 3 20,000 100,000 4 10,000 90,000 5 10,000 90,000 The present value index for this investment is

Answer 1

Answer:

The present value index for this investment is 1.14

Explanation:

Present value index : It shows the ratio between present value of total cash inflows and initial investment

Mathematically,

= Present value of total cash inflows ÷  initial investment

The New machine costing is $400,000 so it would be initial investment as the amount is investment for purchase of machine.

Since all five years amount is given. For calculating the present value of all five years the amount is to be multiplied with discount factor.

Mathematically,

For 1st year = $180,000 × 0.909 = $163,620

For 2nd year = $120,000 × 0.826 = $99120

For 3rd year = $100,000 × 0.751 = $75100

For 4th year = $90,000 × 0.683 = $61470

For 5th year = $90,000 × 0.621 = $55890

The total present value of all 5 year cash inflows = $455,200

So the present value index = $455200 ÷ $400,000

                                              = 1.14

Hence, The present value index for this investment is 1.14