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Oh machine can be purchased for Rs.50,000 machine will contribute Rs.12,000 per year for the next five years has been mean borrowing costs 10% per annum. Determine whether the machine should be purchased or not?
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Oh machine can be purchased for Rs.50,000 machine will contribute Rs.1...
Decision to Purchase Machine
- Cost of Machine: Rs.50,000
- Contribution: Rs.12,000 per year for 5 years
- Borrowing Cost: 10% per annum
Calculation of Net Present Value (NPV)
- NPV is the difference between the present value of cash inflows and the present value of cash outflows over a period of time
- In this case, the cash inflows are the contributions from the machine, and the cash outflows are the cost of the machine and the borrowing costs
- NPV is calculated using the following formula: NPV = (Cash inflows / (1 + r)^n) - (Cash outflows / (1 + r)^n)
- Where r is the discount rate (borrowing cost) and n is the number of years
- Using the given values, we can calculate the NPV as follows:
NPV = (12,000 / (1 + 0.1)^1) + (12,000 / (1 + 0.1)^2) + (12,000 / (1 + 0.1)^3) + (12,000 / (1 + 0.1)^4) + (12,000 / (1 + 0.1)^5) - 50,000
NPV = 10,433.82
Analysis and Conclusion
- If NPV is positive, the investment is profitable and should be undertaken
- If NPV is negative, the investment is unprofitable and should be avoided
- In this case, the NPV is positive (10,433.82), which means that the investment is profitable and should be undertaken
- Therefore, the machine should be purchased as it will generate a positive cash flow over the next 5 years
Limitations
- The calculation of NPV assumes that the cash inflows and outflows are certain and predictable, which may not always be the case in real-world scenarios
- The borrowing cost may change over time, which would affect the NPV
- Other factors such as maintenance costs, replacement costs, and inflation should also be considered when making investment decisions
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Oh machine can be purchased for Rs.50,000 machine will contribute Rs.12,000 per year for the next five years has been mean borrowing costs 10% per annum. Determine whether the machine should be purchased or not?
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