Question

The Johnson Research Organization, a nonprofit organization that does not pay taxes, is considering buying laboratory equipment with an estimated life of seven years so it will not have to use outsiders' laboratories for certain types of work. The following are all of the cash flows affected by the decision: Use Exhibit A.8.

Investment (outflow at time 0)	$	6,000,000
Periodic operating cash flows:
Annual cash savings because outside laboratories are not used		1,400,000
Additional cash outflow for people and supplies to operate the equipment		200,000
Salvage value after seven years, which is the estimated life of this project		400,000
Discount rate		10	%

Required:

Calculate the net present value of this decision. (Round PV factor to 3 decimal places.)

Answer 1

NPV = PVIF - PVOF

Here, PVIF = Present value of cash inflow

        PVOF = Present value of cash outflow

Year	1	2	3	4	5	6	7	Total
PV @ 10%	0.909	0.826	0.751	0.683	0.620	0.564	0.513	4.866

Calculation of PVOF:

Initial investment:                                                         $6,000,000

Additional cash outflow for people and supplies:              $200,000

Total                                                            :            $6,200,000

Less: Salvage value after seven years

($400,000 * PV after seventh year or $400,000 * 0.513)   $205,200          

Net cash outflow $5,994,800

Calculation of PVIF:

PVIF = Annual cash savings * Total of PV after seventh year

        = $1,400,000 * 4.866

       = $6,812,400

Hence, NPV = PVIF - PVOF

                   = $6,812,400 - $5,994,800

                   = $817,600