Question

Tassie Premium Beer (TPB) is considering updating its current manual accounting system with a high-end electronic system. While the new accounting system would help the company save some money, the cost of the system continues to decline over time. TPB’s opportunity cost of capital is 10 per cent, and the costs and values of investments made at different times in the future are as follows:

Year	Cost	Value of Future Savings (At time of purchase)
0	$5,000	$ 7,000
1	4,500	7,000
2	4,000	7,000
3	3,600	7,000
4	3,300	7,000
5	3,100	7,000

Required
A - Using an NPV analysis for each alternative in which year should TPB buy the new accounting system and why?

B - It is sometimes stated that the “net present value approach assumes reinvestment of the intermediate cashflows at the required return.” Is this claim correct? How is it different from the IRR approach? Explain in your own words.

Answer 1

(A)
Year	PVF @ 10%	Cost	PV of cost	Value of future saving-As opportunity cost	PV of saving- As opportunity cost	Saving of opportunity cost- Total cost less gone year	Net Cashflow
(a)	(b)	(c )	(d=b x c)	(e )	(f= b xe)	(g)	(g-d)
0	1	-5000	-5,000	7000	7,000	26,536	21,536
1	0.91	-4500	-4,091	7000	6,364	20,172	16,081
2	0.83	-4000	-3,306	7000	5,785	14,387	11,081
3	0.75	-3600	-2,705	7000	5,259	9,128	6,423
4	0.68	-3300	-2,254	7000	4,781	4,346	2,092
5	0.62	-3100	-1,925	7000	4,346	-	-1,925
		Total		42000	33,536
So, it is evident from above table that as soon as new accounting system will implement give
better benefits. So it is recommended that implement/purchase the new accounting system
immediately.
(B) Yes it correct that NPV approach is based on reinvested of intermediate cash flow at the
required rate as sama is calculated by discounting net cashflow with discounting factor (PV
factor over a certain period. While IRR is the rate at which NPV is getting nil. That is IRR is
the required rate below that rate investment does not acceptable.