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- June 17, 2020 at 2:25 am
I came across two questions on NPV calculation and was unable to understand the differences regarding their capital expenditures involved ; seems similar yet the answer presentation differs.
Q1) Machine no longer in used by the biz can be sold for 90KEur if new product is not produced. If machine is retained for new product production, it is expected to have a residual value of 5KEur at end of the production period. (Product life cycle: 4yrs)
90KEur “a opportunity cost lost” = cash outflow ; Year 0 = -90KEur
5KEur “earning from disposal at end of production” = cash inflow ; Year 4 = +5KEur
Q2) New machine paid immediately for 1.5MEur comes with a 300KEur receivable in the 4th year. Undertaking the proposed project, it is recommended that the existing machine be sold at start of the project for 25KEur at its current book value. However, it has been scheduled to be sold in the 2nd year for 10KEur. (Product has a life of 4yrs)
25KEur “to sell at start of proj” = cash inflow ; Year 0 = +25KEur
10KEur “money lost due to late selling” = cash outflow ; Year 2 = -10KEur
I can understand the answer for Q1 but unable to relate the answer for Q2.
Why wasn’t the answer presentation for Q2 be as below?
25KEur “a opportunity cost lost” = cash outflow ; Year 0 = -25KEur
10KEur “earning from disposal” = cash inflow ; Year 2 = +10KEur
Thank you.June 17, 2020 at 10:02 am
In the second question, if they undertake the project then they will sell the existing machine and will receive cash of 25K at time 0.
If they did not undertake the project then they would wait until time 2 to sell the machine and receive 10K at time 2. So by doing the project they will not receive 10K at time 2 and so there is the opportunity cost of 10K.
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