Question

	Present Generator	New Generator
Purchase cost new	$16,000	$20,000
Remaining book value	$9000
Overhaul needed now	$8000
Annual cash operating cost	$12,500	$7500
New economic life	8 years	10 years
Salvage value now	$4000
Salvage value in 8 years	$3000	$6000
Salvage value in 10 years	0	$1000

If the hospital keeps and overhauls its present generator, then the generator will be usable for eight more years. If a new generator is purchased, it will be used for eight years until a new hospital building is opened. The new generator would be diesel-powered resulting in a substantial reduction in annual operating costs as shown above.

The hospital computes depreciation on a straight-line basis. All purchases are evaluated using a 16% discount rate.

Required:

Determine the net present value for each option.

What option would you advise be selected and why?

Answer 1

Answer-

NPV(net present value ) is the difference between the amount of cash outflow and cash inflow over a particularized period.It uses interest/discount factor while considreing calcutiong profitablity of a capital project.

	Present Generator
	End of year	N.C.F.	Dis Rate @0.16	Present Value
	1	2	3	4=2*3
	1	12,500	0.862	10,776
	2	12,500	0.743	9,290
	3	12,500	0.641	8,008
	4	12,500	0.552	6,904
	5	12,500	0.476	5,951
	6	12,500	0.410	5,131
	7	12,500	0.354	4,423
	8	9,500(salvage value -3,000)	0.305	2,898
	9			-
	10			-
Total Cash Outflow				53,380
Add: Overhaul		8,000
Working Capital		-
		8,000		8,000
NPV				$                                                      61,380

	New Generator
	End of year	N.C.F.	Dis Rate @0.16	Present Value
	1	2	3	4=2*3
	1	7,500	0.862	6,466
	2	7,500	0.743	5,574
	3	7,500	0.641	4,805
	4	7,500	0.552	4,142
	5	7,500	0.476	3,571
	6	7,500	0.410	3,078
	7	7,500	0.354	2,654
	8	1,500	0.305	458	Including 6,000 of salvage value
	9			-
	10			-
Total Cash Outflow				30,747
Add: Investment		20,000
Less Salvage value of old machine		(4,000)
		16,000		16,000
NPV				$           46,747

	Investment	NPV(cost)
Present Generator	8,000.00	61,380
New Generator	20,000.00	46,747

New generator option is better than present generator as it will result in less cost as per calculation showed above.

*There is no revenue mention in question hence decision has been taken on the cost basis.