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) $ 6,950,000 Periodic operating cash flows: Annual cash savings because outside laboratories are not used 1,420,000 Additional cash outflow for people and supplies to operate the equipment 220,000 Salvage value after seven years, which is the estimated life of this project 420,000 Discount rate 6 % Required: Calculate the net present value of this decision. (Round PV factor to 3 decimal places.) Should the organization buy the equipment? Yes No

Answer 1

Solution:

Calculation of Net Present value
	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
Annual Cash Savings	1,420,000	1,420,000	1,420,000	1,420,000	1,420,000	1,420,000	1,420,000
Addl Cash Outflow	-220,000	-220,000	-220,000	-220,000	-220,000	-220,000	-220,000
Salvage Value							420,000
Net Cash Inflow/ (Outflow)	1,200,000	1,200,000	1,200,000	1,200,000	1,200,000	1,200,000	1,620,000
PV factor for $1 at end of year	0.943	0.890	0.840	0.792	0.747	0.705	0.665
PV for Net Cash Inflow	1,132,075.47	1,067,995.73	1,007,543.14	950,512.40	896,709.81	845,952.65	1,077,392.52
Total Present value of Cash Inflow	6,978,182
Cash Outflow at Year 0	6,950,000
Net Present Value	28,182

Since NPV is positive, Prganization should buy the equipment

Wowrking Note:

- Annaul cash savings will be cash inflow for the prject hence will increase the total inflow.

- Extra cost of $220,000 will be entered as negative since it decreases the overall cash inflow.

- Salvage value after 7 years is a pure inflow hence will be taken in consideration