Advantage Milling Devices is preparing to buy a new machine for precision milling of special metal alloys. This device can earn $300 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 6%, what is the net present value of the annual cash flows? What is the net present value if the interest rate is not 6%, but 9%? Why does present value fall when interest rates rise?
S = R × X = 300 × 3,000 × 3.465 = $3,118,500; S = R × X = 300 × 3,000 × 3.240 = $2,916,000
NPV falls because higher interest rates create a greater discount on future receipts.
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