The management of Kunkel Company is considering the purchase of a $39,000 machine that would reduce operating costs by $9,000 per year.

The management of Kunkel Company is considering the purchase of a $39,000 machine that would reduce operating costs by $9,000 per year. At the end of the machine’s five-year useful life, it will have zero salvage value. The company’s required rate of return is 11%.

Required:

1. Determine the net present value of the investment in the machine.

2. What is the difference between the total, undiscounted cash inflows and cash outflows over the entire life of the machine?

Explanation

1.

	Now			Years 1-5
Purchase of machine	$	(39,000	)
Reduced operating costs				$	9,000
Total cash flows (a)	$	(39,000	)	$	9,000
Discount factor (11%) (b)		1.000			3.696
Present value (a) × (b)	$	(39,000	)	$	33,264
Net present value	$	(5,736	)

2.

Item	Cash Flow			Years	Total Cash Flows
Annual cost savings	$	9,000		5	$	45,000
Initial investment	$	(39,000	)	1		(39,000	)
Net cash flow					$	6,000

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