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NPV for new production or lease option

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8. Proust Manufacturing Co. produces personal fitness machines sold through infomercials. The once successful line is no longer selling well, so the company is considering production of a new improved cardio-vascular machine. The project's expected after tax cash flow is given below. The after tax cash flow at time zero, $-700,000, is the cost of equipment. As an alternative, rather than purchase the equipment, Proust can instead lease it for four equal annual payments of $185,000 paid at the beginning of each year. The required rate of return (hurdle rate) for this business is 11 percent.

Time After Tax
Cash Flow (net)
Year 0 -700,000
Year 1 375,000
Year 2 250,000
Year 3 140,000
Year 4 75,000

Required:

Calculate the net present value of both the new production option and of the lease option. Determine the best option for Proust and justify your answer.

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The solution explains the calculation of NPV for new production or lease option

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NPV and IRR for business decision

See attached file.

A local businessman decides to purchase a specialized piece of production equipment at a capital cost of $403,000. The businessman manufactures cardboard boxes, and a particular machine is essential in the production process. The firm will save annual machine leasing costs of $104,000 per year. The machine has an asset life of 6 years. The cost of capital of the bank loan required to fund the project is 11%. You have been hired as a consultant to assist the firm in determining whether to purchase this equipment. Using both NVP and IRR calculations, advise the local businessman whether the machine should be purchased or not.

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