Potential Investments To Accelerate Profit At ABC Company
Potential Investments To Accelerate Profit Abc Company Has The Option
Potential investments to accelerate profit: ABC company has the option to purchase additional equipment that will cost about $42,000, and this new equipment will produce the following savings in factory overhead costs over the next five years: Year 1, $15,000 Year 2, $13,000 Year 3, $10,000 Year 4, $10,000 Year 5, $6,000 ABC Company uses the net-present-value method to analyze investments and desires a minimum rate of return of 12% on the equipment. a. What is the net present value of the proposed investment ignore income taxes and depreciation?
Paper For Above instruction
The decision to invest in new equipment hinges on evaluating its financial viability through methods such as net present value (NPV). In this case, ABC Company considers purchasing equipment costing $42,000, with projected savings in factory overhead costs over five years. To determine if this investment is worthwhile, calculating the NPV is essential, particularly given the company's required minimum rate of return of 12%. This analysis involves discounting the future savings to their present value and comparing the total to the initial investment.
First, we need to identify the projected savings and the discount rate. The savings are expected to be $15,000 in Year 1, $13,000 in Year 2, $10,000 in Year 3, $10,000 in Year 4, and $6,000 in Year 5. The company's minimum acceptable rate of return is 12%, which will be used as the discount rate for calculating the present value of each year's savings.
To proceed, we calculate the present value (PV) of each year's savings by applying the formula:
PV = Future Value / (1 + r)^n
Where:
- Future Value is the savings for the year
- r is the discount rate (12% or 0.12)
- n is the year number
Calculations of Present Values
- Year 1: PV = $15,000 / (1 + 0.12)^1 = $15,000 / 1.12 ≈ $13,392.86
- Year 2: PV = $13,000 / (1 + 0.12)^2 = $13,000 / 1.2544 ≈ $10,364.28
- Year 3: PV = $10,000 / (1 + 0.12)^3 = $10,000 / 1.4049 ≈ $7,122.20
- Year 4: PV = $10,000 / (1 + 0.12)^4 = $10,000 / 1.5735 ≈ $6,357.49
- Year 5: PV = $6,000 / (1 + 0.12)^5 = $6,000 / 1.7623 ≈ $3,404.03
Total Present Value of Savings
Adding these present values gives:
PV total = $13,392.86 + $10,364.28 + $7,122.20 + $6,357.49 + $3,404.03 ≈ $40,641.86
Subtracting the initial investment of $42,000 from the total PV of savings provides the net present value:
NPV = $40,641.86 - $42,000 ≈ -$1,358.14
This negative NPV indicates that, based on a 12% discount rate, the investment would not meet the company’s minimum return requirement and would result in a net loss of approximately $1,358.14.
In conclusion, evaluating the investment’s NPV reveals that, under these projections and discount rate, the proposed equipment purchase would not be financially justified from the company's perspective. The decline in net value suggests that unless the savings estimates increase or the cost decreases, the company should reconsider proceeding with this investment.
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