Question

Your company is considering investing in new material handling equipment for your warehouse. The new equipment will allow for savings in fuel and maintenance costs each year over 6 years. The first year savings is expected to be $3000 and that savings will decrease by $400 each subsequent year (i.e. $2600 savings year 2, $2200 savings year 3, and so on). The new equipment would cost $20,000 today, and at the end of 6 years it would have zero value. Your company would take out this money from an investment account that pays 5% nominal interest compounded annually. Is it worth buying the new material handling equipment? Why or Why not?

Answer 1

The decision about whether machine should be purchased or not is depend upon Net Present Value.
If it has positive net present value, It will be advisable to invest otherwise not.
Step-1:Calculation of present value of annual savings
Year	Saving	Discount factor @5%			Present Value
1	$        3,000		0.952381		$ 2,857.14
2	2,600		0.907029		2,358.28
3	2,200		0.863838		1,900.44
4	1,800		0.822702		1,480.86
5	1,400		0.783526		1,096.94
6	1,000		0.746215		746.22
	Total				10,439.88
Step-2:Calculation of Net Present Value
Present Value of annaul savings					10,439.88
Less cost of equipment					20,000.00
Net Present Value					-9,560.12
Decision:
As per the above calculation, it is observed that project has negative net present value and so it will not be beneficial to invest.
Thus,
It is not worth buying the new Equipment.
Because, it has negative net present value it shows that as of today we are losing money in such investment.
So, the decision is not to investment in the equipment.