A new operating system for an existing machine is expected to cost $750,000 and have a useful life of six years. The system yields an incremental after-tax income of $160,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $29,200. A machine costs $510,000, has a $30,500 salvage value, is expected to last eight years, and will generate an after-tax income of $74,000 per year after straight-line depreciation. Assume the company requires a 12% rate of return on its investments.
Compute the net present value of each potential investment.
Net Present Value:
The net present value is a capital budgeting technique that helps the management to identify economically feasible investment alternatives. Any alternative is feasible only if its net present value is more than zero.
Answer and Explanation: 1
First, we need to calculate the straight-line depreciation on both machines.
For Machine I
- Cost of Machine = $750,000
- Salvage Value = $29,200
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fromChapter 5 / Lesson 20
Learn about what net present value is, how it is calculated both for a lump sum and for a stream of income over multiple years. View some examples on NPV.