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Equipment costs $100,000 and gives net cash flows of $24,000 a year for six years. The present value of an annuity of $1 at 6% for six periods is 4.91731. What is the net present value?
A$44,000
B$18,016
C$118,016
D$24,000
Answer & Solution
Correct answer: B. $18,016
1. Equal annual cash flows may be discounted in one step using the annuity factor.
2. $24,000 times 4.91731 gives $118,016 of discounted net cash flow.
3. Net present value is that discounted total minus the cost of the asset.
4. $118,016 minus $100,000 gives $18,016.
5. A positive net present value means the asset more than pays for itself over time, so it may be accepted.
6. $118,016 is the present value of the inflows before the purchase price is deducted.
7. $44,000 is the undiscounted surplus of $144,000 over $100,000, which ignores the time value of money entirely.
_Source: Jonick, Principles of Managerial Accounting (UNG Press, CC BY-SA 4.0), section 9.8 Capital Investment Analysis_
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