3 1 20 25 20 20 assume the following data for a

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1-20 25-20 20 Assume the following data for a proposed investment in new equipment: Equipment Illustration Cost of new equipment $200,000 Expected useful life 5 years Minimum desired rate of return 10% Expected cash flows to be received each year: Year 1 $70,000 Year 2 60,000 Year 3 50,000 Year 4 40,000 Year 5 40,000 Total expected cash flows $260,000 3
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1-21 25-21 21 The present value of the net cash flow is computed by multiplying the net cash flow by the present value factor of $1 for that year as shown in Slides 22 through 27 . 3
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1-22 25-22 22 $ 63,630 $70,000 × 0.909 (n = 1; i =10%) Jan. 1 2010 Dec. 31 2010 Dec. 31 2011 Dec. 31 2012 Dec. 31 2013 Dec. 31 2014 $(200,000) $70,000 $60,000 $50,000 $40,000 $40,000 3
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1-23 25-23 23 $(200,000) $70,000 $60,000 $50,000 $40,000 $40,000 $60,000 × 0.826 (n = 2; i = 10%) Jan. 1 2010 Dec. 31 2010 Dec. 31 2011 Dec. 31 2012 Dec. 31 2013 Dec. 31 2014 $ 63,630 $ 49,560 3
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1-24 25-24 24 $ 63,630 $(200,000) $70,000 $60,000 $50,000 $40,000 $40,000 $ 49,560 $ 37,550 $50,000 × 0.751 (n = 3; i = 10%) Jan. 1 2010 Dec. 31 2010 Dec. 31 2011 Dec. 31 2012 Dec. 31 2013 Dec. 31 2014 3
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1-25 25-25 25 $ 63,630 $(200,000) $70,000 $60,000 $50,000 $40,000 $40,000 $ 49,560 $ 37,550 $ 27,320 $40,000 × 0.683 (n = 4; i =10%) Jan. 1 2010 Dec. 31 2010 Dec. 31 2011 Dec. 31 2012 Dec. 31 2013 Dec. 31 2014 3
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1-26 25-26 26 $ 63,630 $(200,000) $70,000 $60,000 $50,000 $40,000 $40,000 $ 49,560 $ 37,550 $ 27,320 $40,000 × 0.621 (n = 5; i = 10%) $ 24,840 Jan. 1 2010 Dec. 31 2010 Dec. 31 2011 Dec. 31 2012 Dec. 31 2013 Dec. 31 2014 3
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1-27 25-27 27 $ 63,630 $(200,000) $70,000 $60,000 $50,000 $40,000 $40,000 $ 49,560 $ 37,550 $ 27,320 $ 24,840 $ 2,900 Net present value The equipment should be purchased because the net present value is positive. Jan. 1 2010 Dec. 31 2010 Dec. 31 2011 Dec. 31 2012 Dec. 31 2013 Dec. 31 2014 3
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1-28 25-28 28 When capital investment funds are limited and the alternative proposals involve different amounts of investment, it is useful to prepare a ranking of the proposals by using a present value index . Present Value Index 3
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1-29 25-29 29 Internal Rate of Return Method The internal rate of return (IRR) method uses present value concepts to compute the rate of return from a capital investment proposal based on its expected net cash flows. This method, sometimes called the time- adjusted rate of return method , starts with the proposal’s net cash flows and works backward to estimate the proposal’s expected rate of return.
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