Question

I have a friend who owns a home business of cloth diapers. She was mentioning about investing more in equipment to make more diapers. For example, the equipment needed would costs around $10,000 from the bank at 5% interest rate to buy a new sawing machine. The new investment will earn her about $2,600 a year. The equipment lifetime is about 3 years. Equipment salvageable price is $3,000. What will the cash flow be?

Answer 1

Initial Investment Outlay :
Equipment Cost = $10000

Operating Cash Flow :
Earnings for each of the next 3 years = $2600
Interest Expense each year = $10000 * 5% = $500
Additional Net Cash flow = Increase in Earnings - Increase in cost
= $2600 - $500
= $2100

Terminal Cash Flow :
Salvage Value of the equipment = $3000

Net Cash Flow :
= Operating Cash Flow + Terminal Cash Flow - Initial Cash Outlay
= ($2100 x 3) + $3000 - $10000
= (-) $700

Conclusion :
This decision is having a net cash outflow of $700 during the 3 year time period.


(Ignoring taxation effect and the present value effect)