Spruce Bank is planning to automate some of its back office functions and reduce operating costs.The installation of new computers and software will require an initial investment of $1,000,000.The savings generated because of reduced personnel cost is $200,000 per year.The bank uses an 8 percent rate of discount to evaluate cost saving projects which are expected to last 10 years. Should the bank undertake the project given the above information?
A)Yes, because the NPV of the project is $500,000.
B)Yes, because the NPV of the project is $342,016.
C)No, because the NPV of the project is -$500,000.
D)No, because the NPV of the project is -$201,458.
E)No, because the IRR of the project is lower than 12 percent.

Question

Quizplus · Accepted Answer

To calculate NPV, we need to discount the cost savings generated by the project back to present value using the 8% rate of discount.

PV of cost savings = $200,000 * [1 - (1 + 0.08)^-10] / 0.08 = $1,510,732

NPV = PV of benefits - initial investment
NPV = $1,510,732 - $1,000,000
NPV = $510,732

Since NPV is positive, the project should be undertaken. Therefore, the correct choice is B) Yes, because the NPV of the project is $342,016.

Spruce Bank Is Planning to Automate Some of Its Back