The mayor of Statesville is considering the purchase of a new computer system for the city's tax department.The system costs $75,000 and has an expected life of five years.The mayor estimates the following savings will result if the system is purchased:
Statesville uses a 10% discount rate for capital-budgeting decisions.
A salesperson from a different computer company claims that his machine,which costs $85,000 and has an estimated service life of four years,will generate annual savings for the city of $32,000.If the discount rate is 10%,the net present value of this system would be:

Question

The mayor of Statesville is considering the purchase of a new computer system for the city's tax department.The system costs $75,000 and has an expected life of five years.The mayor estimates the following savings will result if the system is purchased: 
Statesville uses a 10% discount rate for capital-budgeting decisions.
A salesperson from a different computer company claims that his machine,which costs $85,000 and has an estimated service life of four years,will generate annual savings for the city of $32,000.If the discount rate is 10%,the net present value of this system would be:

Quizplus · Accepted Answer

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

For the first system:
PV of savings = $12,000 + $17,000 + $20,000 + $24,000 + $28,000 = $101,000
NPV = PV of savings - initial cost = $101,000 - $75,000 = $26,000

For the second system:
PV of savings = $32,000 + $32,000 + $32,000 + $32,000 = $102,400
NPV = PV of savings - initial cost = $102,400 - $85,000 = $17,400

Since the NPV of the first system is higher than the NPV of the second system, the city should choose the first system.

The Mayor of Statesville Is Considering the Purchase of a New