Advantage Milling Devices Is Preparing to Buy a New Machine

question 181

Essay

Advantage Milling Devices is preparing to buy a new machine for precision milling of special metal alloys. This device can earn $200 per hour, and can run 3,000 hours per year. The machine is expected to be this productive for four years. If the interest rate is 5%, what is the net present value of the annual cash flows? What is the net present value if the interest rate is not 5%, but 8%? Why does present value fall when interest rates rise?

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Definitions:

Internal Rate of Return

A financial metric used to estimate the profitability of potential investments, calculating the discount rate that makes the net present value of all cash flows from the investment equal to zero.

Present Value

The present value of a future amount of money or a series of cash flows, calculated using a given interest rate.

Annuity

A finance-related product designed to issue a predetermined series of payouts to an individual, typically aimed at serving as an income source for retirement.

Net Present Value

A calculation that compares the present value of cash inflows to the present value of cash outflows over a period of time, used in capital budgeting to assess profitability of investments.