Humphrey, 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. Humphrey, Inc. requires a 10% rate of return. What is the approximate net present value of this investment?

Question

Humphrey, 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. Humphrey, Inc. requires a 10% rate of return.  What is the approximate net present value of this investment?

Quizplus · Accepted Answer

1. Calculate the present value of the cost savings using the formula: 
PV = cost savings / (1 + r)^n 
where r = 10% and n = number of years 
PV = 7,300 / (1 + 0.1)^1 + 7,300 / (1 + 0.1)^2 + ... + 7,300 / (1 + 0.1)^6 
PV = 7,300 (3.791 + 3.439 + 3.133 + 2.866 + 2.634 + 2.433) 
PV = 38,813

2. Calculate the present value of the cost using the formula: 
PV = cost / (1 + r)^n 
PV = 30,000 / (1 + 0.1)^1 + 30,000 / (1 + 0.1)^2 + ... + 30,000 / (1 + 0.1)^6 
PV = 30,000 (3.791 + 3.439 + 3.133 + 2.866 + 2.634 + 2.433) 
PV = 317,609

3. Calculate the net present value (NPV): 
NPV = present value of cost savings - present value of cost 
NPV = 38,813 - 317,609 
NPV = -$278,796

Since the NPV is negative, the investment should not be made. So, the best choice is B.