Valesano Company is considering a project with the following information:
$\begin{array}{ll}&\text { Project } 1\
\text { Cost } & \$ 4,000 \
\text { Annual cash operating savings(end of year) } & \$ 2,000 \
\text { Terminal salvage } & \$ 0 \
\text { Useful life in years } & 3 \
\text { Required rate of return } & 10 \% \
\text { Present value of one for } 3 \text { periods at } 10 \% & 0.7513
\end{array}$
Present value of ordinary annuity of one for
$\begin{array} { l }
\text {3 periods at 10\% }&2.4869 \
\end{array}$

Ignoring taxes,what is the lowest level of annual cash operating savings that will result in a positive net present value?
A) $1,550
B) $1,600
C) $1,608
D) $2,000

Question

Valesano Company is considering a project with the following information:
$\begin{array}{ll}&\text { Project } 1\
\text { Cost } & \$ 4,000 \
\text { Annual cash operating savings(end of year) } & \$ 2,000 \
\text { Terminal salvage } & \$ 0 \
\text { Useful life in years } & 3 \
\text { Required rate of return } & 10 \% \
\text { Present value of one for } 3 \text { periods at } 10 \% & 0.7513
\end{array}$
Present value of ordinary annuity of one for
$\begin{array} { l  }
 \text {3 periods at 10\% }&2.4869 \
\end{array}$

Ignoring taxes,what is the lowest level of annual cash operating savings that will result in a positive net present value?
A) $1,550
B) $1,600
C) $1,608
D) $2,000

Quizplus · Accepted Answer

To find the lowest level of annual cash operating savings that will result in a positive net present value (NPV), we use the formula for NPV, which is the present value of cash inflows minus the initial investment. The cash inflows are the annual cash operating savings, and the initial investment is $4,000. The present value of an ordinary annuity formula is used to calculate the present value of the cash inflows over the 3-year period at a 10% discount rate.$$ NPV = (Annual\ Cash\ Savings \times PV\ Factor\ for\ Ordinary\ Annuity) - Initial\ Investment $$Given that the present value factor for an ordinary annuity of 1 for 3 periods at 10% is 2.4869, and the initial investment is $4,000, we set the NPV to be greater than 0 and solve for the annual cash savings.$$ 0 < (Annual\ Cash\ Savings \times 2.4869) - 4,000 $$Solving for the annual cash savings gives us the lowest level of annual cash operating savings that will result in a positive NPV. Rearranging the equation:$$ Annual\ Cash\ Savings > \frac{4,000}{2.4869} $$$$ Annual\ Cash\ Savings > 1,608 $$Therefore, the lowest level of annual cash operating savings that will result in a positive NPV is just above $1,608, making option C the correct answer.

Valesano Company Is Considering a Project with the Following Information