Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 55

Calculate NPV, present value ratio, and payback Duncan Company is considering the investment of $140,000 in a new machine. It is estimated that the new machine will generate additional cash flow of $21,000 per year for each year of its 12-year life and will have a salvage value of $15,000 at the end of its life. Duncan’s financial managers estimate that the firm’s cost of capital is 12%.

Required

a. Calculate the net present value of the investment.

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b. Calculate the present value ratio of the investment.

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c. What is the internal rate of return of this investment, relative to the cost of capital?

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d. Calculate the payback period of the investment.

Step 1 of 6

NPV, present value ratio, internal rate of return, and payback period

Net present value (NPV ): NPV is the distinction in terms of present value between the cash inflows and cash outflows.

Present value ratio : It shows the present value of inflows in proportion to the present value of investment or cash outflows.

Internal rate of return (IRR ): It refers to the interest rate that makes the summation of all cash inflows and outflows zero, and is helpful in comparing an investment with another.

Payback period : The duration of time essential to recover the investment cost of a specified portfolio.