Your buddy in mechanical engineering has invented a money machine. The main drawback of the machine is that it is slow. It takes one year to manufacture $ 700. However, once built, the machine will last forever and will require no maintenance. The machine can be built immediately, but it will cost $ 12 comma 100 to build. Your buddy wants to know if he should invest the money to construct it. If the interest rate is 5.5 % per year, what should your buddy do? What is your advice if the machine takes one year to build?

Question

contestada

Respuesta :

DeniceSandidge DeniceSandidge · Answer 1 · 2019-10-16T10:57:26+02:00

Answer:

NPV of machine is - $624.27

your buddy should not take up the project

in case NPV at year 0 will be negative and hence the project should be rejected

Explanation:

given data

one year to manufacture = $700

cost = $12,100

interest rate = 5.5 %

solution

we consider here in year 0 machine is built and Machine cost = $12,100

and at the end of year 1 cash flow = $700

so this cash flow is perpetual

and

PV of cash flow = [tex]\frac{cash flow}{interest}[/tex]

PV of cash flow = [tex]\frac{700}{0.055}[/tex]

PV of cash flow = $12727.27

so

NPV will be

NPV = PV of cash flow - Machine cost

NPV = $12727.27 - $12100

NPV = - $624.27

so NPV of machine is - $624.27

Since NPV is negative, your buddy should not take up the project.

and

If the machine takes one year to build then NPV at the end year1 = -$624.27

so here in case NPV at year 0 will be negative and hence the project should be rejected