Question

Advanced Digital Design is analyzing a capital investment project for using new computing technology to reduce current operating costs. The new computing technology will have a five-year life with no salvage value at the end of five years. Advanced Digital Design’s cost of capital is 12%. Relevant cash flows and present value factors for 5 years @ 12% are as follows: Investment in computer technology = $500,000. Annual net cash savings from new computer technology = $135,000. Salvage value of new computer technology = $0. Present value of $1 = 0.5674 Present value of an annuity of $1 = 3.6048 The net present value of the investment in new computing technology is: A) $(423,401) B) $ (13,352) C) $76,599 D) $175,000

Answer 1

Answer)

The correct Net Present value for the given capital investment is (B) $ (13,352).

Calculation of Net Present Value of New Computing Technology

Net Present value =Present value of cash inflows – Present value of cash outflows

                               = (Annual Cash savings X Present value of Annuity of $ 1 for 5 years at 12%) – (Cash outflow X Discounting factor)

                                         = ($135,000 X 3.6048) – ($500,000 X 1)

                                          = $486,648 - $ 500,000

                                         = $ (13,352).

Notes:

• We have taken discounting factor for present value of cash outflows to be “1” as investment will be made today.
• Since the salvage value of equipment at the end of 5 years is “0”, the present value factor at the end of 5 years given in the question (i.e. 0.5674) is not relevant.