Asked by eunice morel on Apr 26, 2024
Verified
Dexter Company is considering purchasing equipment. The equipment will produce the following cash flows: Year 1 $120,000 Year 2 $200,000\begin{array} { l l } \text { Year 1 } & \$ 120,000 \\\text { Year 2 } & \$ 200,000\end{array} Year 1 Year 2 $120,000$200,000 Dexter requires a minimum rate of return of 10%. What is the maximum price Dexter should pay for this equipment?
A) $274381
B) $165290
C) $320000
D) $160000
Rate Of Return
A measure of the gain or loss on an investment over a specified period, expressed as a percentage of the investment’s initial cost.
Cash Flows
The net amount of cash being transferred into and out of a business, typically categorized into operating, investing, and financing activities.
- Assess investment prospects by calculating their current and anticipated values.
Verified Answer
MA
Maria AnagnostopoulosApr 26, 2024
Final Answer :
A
Explanation :
To find the maximum price Dexter should pay for the equipment, we calculate the present value of the cash flows at the required rate of return of 10%. The present value (PV) formula is: PV=CF1(1+r)1+CF2(1+r)2PV = \frac{CF_1}{(1+r)^1} + \frac{CF_2}{(1+r)^2}PV=(1+r)1CF1+(1+r)2CF2 where CF1CF_1CF1 and CF2CF_2CF2 are the cash flows in Year 1 and Year 2, respectively, and rrr is the rate of return.Substituting the given values: PV=120,000(1+0.10)1+200,000(1+0.10)2PV = \frac{120,000}{(1+0.10)^1} + \frac{200,000}{(1+0.10)^2}PV=(1+0.10)1120,000+(1+0.10)2200,000PV=120,0001.10+200,0001.21PV = \frac{120,000}{1.10} + \frac{200,000}{1.21}PV=1.10120,000+1.21200,000PV=109,090.91+165,289.26PV = 109,090.91 + 165,289.26PV=109,090.91+165,289.26PV=274,380.17PV = 274,380.17PV=274,380.17 Rounded to the nearest dollar, the maximum price Dexter should pay for the equipment is $274,381.
Learning Objectives
- Assess investment prospects by calculating their current and anticipated values.