Hunt Inc. intends to invest in one of two competing types of computer-aided manufacturing equipment: CAM X and CAM Y. Both CAM X

Question

2 years ago

8

Hunt Inc. intends to invest in one of two competing types of computer-aided manufacturing equipment: CAM X and CAM Y. Both CAM X

and CAM Y models have a project life of 10 years. The purchase price of the CAM X model is $3,600,000, and it has a net annual after-tax cash inflow of $900,000. The CAM Y model is more expensive, selling for $4,200,000, but it will produce a net annual after-tax cash inflow of $1,050,000. The cost of capital for the company is 10%.
Required:
Calculate the NPV for each project.

Business

1 answer:

timofeeve [1] · Answer 1 · 2022-03-16T05:34:53+03:00

Answer:

NPV of CAM X = $1,930,110.40

NPV of CAM Y = $2,251,795.46

Explanation:

The NPV for each project can be calculated using the following steps:

Step 1: Calculation of present value (PV) for each project

The PV for each project can be calculated using the formula for calculating the present value of an ordinary annuity as follows:

PV of a project = P * [{1 - [1 / (1 + r)]^n} / r] …………………………………. (1)

Where;

For CAM X

P = Net annual after-tax cash inflow = $900,000

r = Cost of capital or interest rate = 10%, or 0.10

n = number of project life = 10

Substitute the values into equation (1) to have:

PV of CAM X = $900,000 * [{1 - [1 / (1 + 0.10)]^10} / 0.10]

PV of CAM X = $900,000 * 6.14456710570468

PV of CAM X = $5,530,110.40

For CAM Y

P = Net annual after-tax cash inflow = $1,050,000

r = Cost of capital or interest rate = 10%, or 0.10

n = number of project life = 10

Substitute the values into equation (1) to have:

PV of CAM Y = $1,050,000 * [{1 - [1 / (1 + 0.10)]^10} / 0.10]

PV of CAM Y = $1,050,000 * 6.14456710570468

PV of CAM Y = $6,451,795.46

Step 2: Calculation of net present value (NPV) for each project

The NPV for each project can be calculated using the following formula:

NPV of each project = PV of each equipment - Purchase price of each equipment ........ (2)

Using equation (2), we have:

NPV of CAM X = PV of CAM X - Purchase price of CAM X = $5,530,110.40 - $3,600,000 = $1,930,110.40

NPV of CAM Y = PV of CAM Y - Purchase price of CAM Y = $6,451,795.46 - $4,200,000 = $2,251,795.46

Additional Note:

Although this not part of the requirement of the question, but note that the final decision is that since the positive NPV of $2,251,795.46 for CAM Y is gereater than the positive NPV of $1,930,110.40 for CAM X, Hunt Inc. will choose to invest in CAM Y.