Reem Company is considering buying a machine. The firm’s required rate of return is 10%. Find payback period

Reem Company is considering buying a machine. The firm’s required rate of return is 10%. Find payback period

 

 

answer:

 

Year Cash Flows Cumulative cash flows
0 ($30,000) ($30,000)
1 $6,000 ($24,000)
2 $6,000 ($18,000)
3 $6,000 ($12,000)
4 $6,000 ($6,000)
5 $6,000 $0

The payback year is 5 years because in this year the cumulative cash flows is equal to the initial investment .

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b) The NPV = – $ 30,000 + $ 6000 / 1.101 +   $ 6000 / 1.102 + $ 6000 / 1.103 + $ 6000 / 1.104 + $ 6000 / 1.105

NPV = -$ 7255.28

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c) The ratio, called a profitability index (PI), is calculated by dividing the present value of expected future cash flows by the amount of the initial cash outlay

Year Cash Flows Present value of cash flows
0 ($30,000)
1 $6,000 5454.55
2 $6,000 4958.68
3 $6,000 4507.89
4 $6,000 4098.08
5 $6,000 3725.53
Total 22744.72

PI = $ 22,744.72 / $ 30,000

PI = 0.76

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d) The company should not purchase the machine because the Net present value of the machine is negative and also the profitability index is less than one .

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