Cleaners, Inc.is considering purchasing equipment costing $30,000 with a 6-year useful life.The equipment will provide cost savings of $7,300 and will be depreciated straight-line over its useful life with no salvage value.Cleaners, Inc.requires a 10% rate of return.What is the approximate net present value of this investment?

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV), we need to find the present value of the cost savings and subtract the initial investment.

PV of cost savings = $7,300

To find the initial investment, we need to use the straight-line depreciation formula:

Depreciation per year = Cost of equipment / Useful life 
Depreciation per year = $30,000 / 6 = $5,000

So the initial investment is:

Initial investment = Cost of equipment - PV of depreciation 
Initial investment = $30,000 - PV of an annuity factor (n=6, i=10%, PMT=$5,000) 
Initial investment = $30,000 - $18,208 
Initial investment = $11,792

Now we can calculate the NPV:

NPV = PV of cost savings - initial investment 
NPV = $7,300 - $11,792 
NPV = -$4,492

Since the NPV is negative, the investment is not profitable and should not be undertaken. Therefore, the best choice is B.