Question

Debby�s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $27,900. Debby is not sure how many members the new equipment will attract, but she estimates that her increased annual cash flows for each of the next five years will have the following probability distribution. Debby�s cost of capital is 15 percent.Cash FlowProbability$4,570.15,550.37,400.49,930.2A.) What is the expected value of the cash flow? The value you compute will apply to each of the five years.B.) What is the expected net present value?C.) Should Debby buy the new equipment?

Answer 1

Answer:

expected cash flow will be 7,068

 NPV = (4,206.97)

It should not purchase this equipment as their present value is negative.

Explanation:

We do weighted average to get the etimated cash flow

$\left[\begin{array}{ccc}Cash Flow&Probability&Prediction\\4,570&0.1&457&5,550&0.3&1,665&7,400&0.4&2,960&9,930&0.2&1,986&&1&7068&\end{array}\right]$

is important to always have the sum of probabilities equal to 1.

For this method, the expected cash flow will be 7,068

Now we calculate the NPV of the equipment doing the annuity of the cash flow

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$

C 7068

time 5

rate 0.15

$7068 \times \frac{1-(1+0.15)^{-5} }{0.15} = PV$

PV $23,693.03

NPV = PV cash flow - investment

NPV = 23,693.03 - 27,900

NPV = (4,206.97)