Corporate Finance

Good Student
Posts: 24
Joined: Wed Dec 09, 2015 9:29 am

Corporate Finance

Postby rishabhhurkat » Mon Mar 07, 2016 6:41 am

Plasma Inc is considering the purchase of an automatic capping machine to reduce labour costs. The machine is projected to save Plasma $5,000 per year. The machine costs $40,000 and is expected to last for 15 years. Plasma has estimated that their cost of capital for such an investment is 10%. For an extra $750 per year, Plasma can get a “Good As New” service contract. The contract keeps the machine in new condition forever. Net of the cost of the service contract, the machine would produce cash flows of $4250 per year in perpetuity. Which of the following decisions is the most appropriate?
Choose one answer.
a. Plasma should not avail of the service contract Incorrect
b. Plasma’s profitability would increase if it accepts the service contract Correct
c. Plasma should not accept the entire project in the first place Incorrect

The correct answer is B.
The NPV for purchase of machine only is negative (-$1970), however with the service contract the NPV is positive $2500 and the IRR is more than the WACC of the firm (10.81%).

Please explain me how come NPV of $2500 and IRR of 10.81% is Calculated??

Posts: 3
Joined: Mon Mar 07, 2016 6:02 am

Re: Corporate Finance

Postby nehad » Wed Mar 09, 2016 12:23 pm

in this calculation we have given things are
Number of years=15
cost of capital=10% and FV=0 then PV=38030.39 from this following values which are given,
NPV=PV-Out Flow
NPV= -1969.61
however for the service contract
PV is 42500 and Cost is 40000 new NPV=2500
and the NPV is positive it means that you are paying less than the asset worth, and it is because of service contract.

Good Student
Posts: 24
Joined: Wed Dec 09, 2015 9:29 am

Re: Corporate Finance

Postby rishabhhurkat » Thu Mar 10, 2016 9:36 am

Ok...Got it...Thank You Very Much

Return to “CFA Level I”


Global Association of Risk Professionals, Inc. (GARP®) does not endorse, promote, review or warrant the accuracy of the products or services offered by EduPristine for FRM® related information, nor does it endorse any pass rates claimed by the provider. Further, GARP® is not responsible for any fees or costs paid by the user to EduPristine nor is GARP® responsible for any fees or costs of any person or entity providing any services to EduPristine Study Program. FRM®, GARP® and Global Association of Risk Professionals®, are trademarks owned by the Global Association of Risk Professionals, Inc

CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by EduPristine. CFA Institute, CFA®, Claritas® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Utmost care has been taken to ensure that there is no copyright violation or infringement in any of our content. Still, in case you feel that there is any copyright violation of any kind please send a mail to and we will rectify it.