Question

A clothing manufacturing firm is deciding whether or not to invest in new machinery. The machinery costs $45,000 and is expected to increase cash flows in the first year by $25,000 and in the second year by $30,000. The firm currently charges $18 per unit. If the interest rate is 5% then the present value of the cash flows is

Answer 1

The present value of the cash flows is 51020.41

What is Compound Interest?

Compound interest, often known as interest on principal and interest, is the adding of interest to the loan or deposit principal. It occurs when interest is reinvested, added to the lent capital instead of being paid out, or the borrower is required to pay it, resulting in the next period's interest being generated on the principal amount plus any accumulated interest.

In the question it is given that:

Equipment cost $45,000.

first year's cash flow was $25,000

second-year cash flow $30000

5% interest is charged.

We are aware that the following relationship can be used to calculate the present value.

$PV = FV X (1+r)^{n}$

PV stands for present value, Future Value is FV, and the rate of interest is r.

Consequently, the present value is calculated as

$PV = 25000 X (1+0.05)^{-1} + 30000 X (1+0.05)^{-2}$

⇒ PV = 51020.41

To learn more about compound interest visit:

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