Question

A firm is considering the purchase of a $500,000 machine for its business. The machine is expected to increase sales by $237,000. The machine will have a 5 year useful life and will be depreciated over 5 years via the straight line method. There is no salvage value. The firm has a required rate of return of 10% for all new capital investments. The project's pro forma income statement is shown below:


Sales $237,000
Total Cost 137,000
Depreciation 100,000
EBIT $0
Taxes 0
Net income $0

The firm should: ___________

a. Accept the project because the NPV is $2,543
b. Accept the project because the NPV is $10,011
c. Reject the project because the NPV is negative $120,921
d. Reject the project because the NPV is negative $500,000
e. It doesnt matter since the NPV is 0
f. Cant tell since there isnt enough information

Answer 1

Answer:

c. Reject the project because the NPV is negative $120,921

Explanation:

As we know that the depreciation is a non-cash expense so here we need to add the depreciation expense again

Now the cash inflow would be $100,000 each year i.e. for 5 years

And, the initial investment is $500,000

Now we have to use the formula of NPV in an excel by using the NPV function

=NPV(rate,Year1 to Year5 cashflows)-Year0 cashflow

=NPV(10%,Year1 to Year5 cashflows)-500000

=-120,921

So as we can see that the npv comes in negative so the project should be rejected

Therefore the correct option is c.