Major Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $100,000. The equipment will have an initial cost of $500,000 and have an 8-year life. The equipment has no salvage value. The hurdle rate is 8%. Ignore income taxes. Answer the following:a. What is the net present value?b. What would the net present value be with a 12% hurdle rate?c. Based on the NPV calculations, in what range would the equipment's internal rate of return fall?
What will be an ideal response?
a. $74,660 = ($100,000 × 5.7466) ? $500,000
b. ($3,240) = ($100,000 × 4.9676) ? $500,000
c. IRR is between 8% and 12% (11.81%)
Net present value is calculated by discounting the annual cash flows and subtracting the initial investment. Internal rate of return is the rate where net present value equals zero.
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