51. A manufacturing company is considering purchasing a new machine for $120,000. If the required rate of return is 8%, the NPV is calculated to be $18,000. Should the company proceed with the purchase?
Answer: D
Yes, because the NPV is positive, indicating the investment adds value.
The company should proceed with the purchase as the NPV of $18,000 is positive. This indicates that the investment is expected to generate more cash than the cost of capital, thereby adding value to the company.
A) No, because the initial cost is greater than the NPV.
This option is incorrect because while the initial cost of the machine is indeed $120,000, the NPV of $18,000 signifies that the investment will yield additional value over time, making the initial cost less significant in the context of the investment's overall profitability.
B) No, because the NPV calculation ignores risk.
This option is also incorrect as the NPV calculation factors in the required rate of return, which implicitly includes considerations for risk. A positive NPV indicates that the investment exceeds the threshold return, suggesting that the investment is worthwhile despite associated risks.
C) Yes, because the initial cost is greater than the NPV.
This choice is misleading and incorrect. While it acknowledges a true statement about the relationship between cost and NPV, it fails to recognize that a positive NPV is more critical in evaluating the investment's potential. The initial cost being greater than the NPV does not negate the fact that the investment is still expected to generate profits.
D) Yes, because the NPV is positive, indicating the investment adds value.
This option is correct as a positive NPV of $18,000 indicates that the project is expected to generate sufficient returns over the cost of capital, thus adding value to the company. The decision to proceed with the purchase aligns with sound investment principles.
Conclusion
The correct answer is D, as a positive NPV clearly indicates that the investment is expected to be profitable and add value to the company. Options A, B, and C fail to accurately represent the implications of a positive NPV and misinterpret the relationship between initial costs and expected returns. By proceeding with the investment, the company stands to enhance its financial position.