Dobson Contractors is considering buying equipment at a cost of $75,000. The equipment is expected to generate cash flows of $15
,000 per year for eight years and can be sold at the end of eight years for $5,000. Interest is at 12%. Assume the equipment would be paid for on the first day of year one, but that all other cash flows occur at the end of the year. Ignore income tax considerations. Determine the net present value of the cash flows and if Dobson should purchase the machine.a. $194,256 negative net present value of the cash flows. Based on present value considerations, Dobson Construction should not buy the machine.b. $194,256 positive net present value of the cash flows. Based on present value considerations, Dobson Construction should buy the machine.c. $1,534 negative net present value of the cash flows. Based on present value considerations, Dobson Construction should not buy the machine.d. $1,534 positive net present value of the cash flows. Based on present value considerations, Dobson Construction should buy the machine.
1 answer:
Answer: d. $1,534 positive net present value of the cash flows. Based on present value considerations, Dobson Construction should buy the machine.
Explanation:
To calculate the Net Present Value, we take the present values of all the future cashflows and subtract the initial cost from this amount.
Now, the cashflows are stable and this means that we can use the Present Value of an Annuity factor to find out the present value of the cashflows. We can then use a simple present value formula to find out the PV of the sale price.
I have attached a table that shows the PVIFA factors to make our calculations easier.
With interest rates at 12% and the year being 8 years, the PVIFA factors is 4.9676
Calculating therefore we have,
= 15,000 * 4.9676
= $74,514
This is the present value of 8 years of $15,000 cash flows.
In the same year, the machine can be sold for $5,000 so the present value of that is,
= 5000 / ( 1 + 12%)^8
= $2,020
Adding those together we get,
= 74,514 + 2,020
= 76,534
= $76,534
Subtracting the original cost we have,
= 76,534 - 75,000
= $1,534 in positive cashflow.
Net Present Value = $1,534
This means that Based on present value considerations, Dobson Construction should buy the machine due to a $1,534 positive net present value.
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Answer:
WACC = 9.86%
so correct option is d. 9.86%
Explanation:
given data
cost of equity = 11.6 percent
bonds = 6.2 percent
bonds sell = 103.2 percent
debt book value = $408,000
total assets book value= $952,000
market to book ratio = 2.74 times
to find out
what is the company's WACC
solution
we get here first Total book value of equity that is express as
Total book value of equity = Total assets book value - Total debt book value .................1
Total book value of equity = 952000 - 408000
Total book value of equity = $544000
and here market to book ratio is
market to book ratio =
so market value of equity = (2.74 × 544000) = $1490560
and
After tax cost of debt = 6.2 (1 - tax rate)
After tax cost of debt = 6.2 (1 - 0.4)
After tax cost of debt = 3.72%
and
Market value of Debt = 408000 × 103.2%
Market value of Debt = $421056
so
Total market value = $1490560 + $421056
Total market value is =$1911616
and
WACC will be
WACC = Respective costs × Respective weights
WACC =
WACC = 9.86%
so correct option is d. 9.86%