Question

Jordan Company is considering purchasing new equipment costing $2,400,000. Jordan estimates that the useful life of the equipment will be five years and that it will have a salvage value of $600,000. The company uses straight-line depreciation. The new equipment is expected to have a net cash inflow (before taxes) of $258,000 annually. Assume that the tax rate is 40% and that management requires a minimum return of 14%.
Using the net present value method, determine whether the equipment is an acceptable investment.

Answer 1

Answer:

the project should not be accepted because the NPV is negative

Explanation:

Net present value is the present value of after-tax cash flows from an investment less the amount invested.  

Only projects with a positive NPV should be accepted. A project with a negative NPV should not be chosen because it isn't profitable.  

When choosing between positive NPV projects, choose the project with the highest NPV first because it is the most profitable.

NPV can be calculated using a financial calculator

After tax cash flows = before tax cash flows x ( 1 - tax rate) + depreciation

Straight line depreciation expense = (Cost of asset - Salvage value) / useful life

($2,400,000 - $600,000) / 5 = $360,000

After tax cash flow = ($258,000 x 0.6) + $360,000 = $514,800

Cash flow each year from year 1 to 4 = $514,800

cash flow in year 5 = $514,800  + $600,000

i = 14%

npv = $-321,028.71

To find the NPV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.  

3. Press compute