Question
Slick Company is considering a capital project involving a $225,000 investment in machinery and a $45,000 investment in working capital. The machine has an expected
Slick Company is considering a capital project involving a $225,000 investment in machinery and a $45,000 investment in working capital. The machine has an expected useful life of 10 years and no salvage value. The annual cash inflows (before taxes) are estimated at $90,000 with annual cash outflows (before taxes) of $30,000. The company uses straight-line depreciation. Assume the federal income tax rate is 40%.
The companys new accountant computed the net present value of the project using a minimum required rate of return of 16% (the companys cost of capital). The accountants computations follow:
| Cash inflows |
| $ 90,000 |
|
| Cash outflows |
| 30,000 |
|
| Net cash inflow |
| $ 60,000 |
|
| Present value factor at 16% |
| 4.833 |
|
| Present value of net cash inflow |
| $289,980 |
|
| Initial cash outlay |
| 225,000 |
|
| Net present value |
| $ 64,980 |
|
Required:
a. Are the accountants computations correct? If not, compute the correct net present value.
b. Is this capital project acceptable to the company? Why or why not?
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