IV. 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)?
b. Assuming a 5 year straight line depreciation, how will this impact the factory’s fixed costs for each of the 5 years (and the implied product costs)? What about cash flow?
c. Considering the cash flow impact of the equipment as well as the time value of money, would you recommend that ABC Company purchases the equipment? Why or why not?