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Chapter 13: Problem 1

You are considering buying a new laser printer to use in your part-time desktop publishing business. The printer will cost \(\$ 380,\) and you are certain it will generate additional net revenue of \(\$ 100\) per year for each of the next five years. At the end of the fifth year, it will be worthless. Answer the following questions: a. What is the value of the printer if you could lend funds safely at an annual interest rate of 10 percent? Is the purchase of the printer justified? b. Would your answer to part (a) change if the interest rate were 8 percent? Is the purchase justified in that case? Explain. c. Would your answer to part (a) change if the printer cost \(\$ 350\) ? Is the purchase justified in that case? d. Would your answer to part (a) change if the printer could be sold for \(\$ 500\) at the end of the fifth year? Is the purchase justified in that case? Explain.

Short Answer

Expert verified
The value of the printer for each situation is determined by the PV of the total net revenue for that situation. The purchase of the printer is justified in a situation if the PV of the total net revenue is greater than the cost of the printer for that situation.

Step by step solution

01

Calculate the Present Value for an interest rate of 10 percent

Firstly, calculate the present value (PV) of each year's net revenue, \(100\), for five years, using the formula: PV = CF / (1+r)^n, where CF is the cash flow, r is the interest rate and n is the number of years. The PV of the total net revenue is the sum of the PV of each year's net revenue. If this value is greater than the cost of the printer, \(380,\) then the purchase is justified.
02

Calculate the Present Value for an interest rate of 8 percent

Secondly, repeat the calculations from step 1 with an interest rate of 8 percent. If the new PV of the total net revenue is greater than the cost of the printer, then the purchase is justified at this lower interest rate.
03

Calculate the Present Value for a printer cost of \(350\)

Thirdly, repeat the calculations from step 1 with the new cost of the printer being \(350\). If the PV of the total net revenue is greater than this new cost, then the purchase is justified with this lower cost.
04

Calculate the Present Value including a sale price of \(500\)

Lastly, add the PV of a sale price of \(500\) at the end of the fifth year (calculated with the formula from step 1) to the PV of the total net revenue from step 1. If this new total PV is greater than the initial cost of the printer, then the purchase is justified with this resell value.

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Most popular questions from this chapter

In the market for Amazon.com stock, explain how each of the following events, ceteris paribus, would affect the demand curve for the stock and the stock's price. a. The interest rate on U.S. government bonds rises. b. People expect the interest rate on U.S. government bonds to rise, but it hasn't yet risen. c. Google announces that it will soon start competing with Amazon in the market for books, DVDs, and everything else that Amazon sells.

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Good news! Gold has just been discovered in your backyard. Mining engineers tell you that you can extract five ounces of gold per year forever. Gold is currently selling for \(\$ 400\) per ounce, and that price is not expected to change. If the discount rate is 5 percent per year, estimate the total value of your gold mine.
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