Fill This Form To Receive Instant Help
Fill This Form To Receive Instant Help
Homework answers / question archive / You are in the copy business and your major competitor recently purchased a color laser copier
You are in the copy business and your major competitor recently purchased a color laser copier. You currently do not offer color copies, so you are considering a similar purchase. You estimate the following incremental cash flows if a purchase is made: Cost of copier: $23,000: 9,000 copies per year with a net after-tax inflow of $0.65 per copy: Five-year life of copier with no salvage value; and the project's required return is equal to 11 percent. Based on an analysis of these cash flows, which of the following statements is/are true? The internal rate of return is only 1 percent lower than the required return, indicating a gray area in the decision process, The payback period for this project is 3,1 years. The copier should not be purchased since the net present value is negative $1.379,00 The copier should be purchased since the net present value is $3.500,
Answer is third option the copier should not be purchased since the net present value is negative $1,379.00
Solution:
Required rate of return = 11%
Initial cost = $23,000
Copies per year= 9000
After-tax inflow per copy =$0.65
Number of years = 5
Step 1
Cash inflow per year for 5 years
= Copies per year×inflow per year
= 9,000×0.65
= $5,850
Step 2
Net present value of investment @ 11% or 0.11
= Cost-Present value of inflow
= Cost - {inflow×Annuity(r,n)}
= Cost - {inflow×((1-(1+r)^-n)/r)}
= $23,000-{$5,850×((1-(1+0.11)^-5)/0.11)}
= $23,000-($5,850×3.70)
= $23,000-$21,621
= -$1,379
NPV is $1,379 negative therefore the project should be rejected. Hence third option is correct.
Step 3
Reason why other options and not correct
First option is not correct because even if internal rate of return is less by 1% of required rate of return of 11% i.e 10% then also net present value comes negative
Solution
Net present value of investment @ 10% or 0.10
= Cost-Present value of inflow
= Cost - {inflow×Annuity(r,n)}
= Cost - {inflow×((1-(1+r)^-n)/r)}
= $23,000-{$5,850×((1-(1+0.10)^-5)/0.11)}
= $23,000-($5,850×3.79)
= $23,000-$22,176
= -$824
Therefore first option is not correct
Step 4
Second option is not correct because
| Year | cash flow | Cumulative Cash flow |
| 0 | -23,000 | -23,000 |
| 1 | 5,850 | -17,150 |
| 2 | 5,850 | -11,300 |
| 3 | 5,850 | -5,450 |
| 4 | 5,850 | 400 |
| 5 | 5,850 | 6,250 |
To calculate payback period
Take year with the last negative outflow. So, in this case, it will be year 3
Now divide the total cumulative cash flow in the year in which the cash flows became positive by the total flow of the consecutive year.
So that is: 5450/5850= 0.93
Payback Period =3+0.93
The payback period is 3.93years.
Therefore Payback period is 3.93years and not 3.1years and hence option second is not correct
Step 5
Option four is not correct because we already calculated the net present value and it is negative $1,379 and not $3,500
From Step 2 3 4 and 5 we can say that option 3 is correct and other option cannot be corrected.
