(Ignore income taxes in this problem.) Westland College has a telephone system that is in poor condition. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:

Westland College uses a 10% discount rate and the total cost approach to net present value analysis. The working capital required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life of eight years.

-The net present value of overhauling the present system is closest to:

Question

(Ignore income taxes in this problem.) Westland College has a telephone system that is in poor condition. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:

Westland College uses a 10% discount rate and the total cost approach to net present value analysis. The working capital required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life of eight years.

-The net present value of overhauling the present system is closest to:

Quizplus · Accepted Answer

To calculate the net present value, we need to determine the present value of the cash inflows and outflows. The initial cost of overhauling the system is -$1,200,000. The annual savings from reduced operating costs are $800,000. The salvage value of the system after 10 years is $400,000. We need to discount these cash flows at a rate of 8%, using the present value formula.

PV of initial cost = -$1,200,000
PV of annual savings = $6,997,294
PV of salvage value = $510,222
Net present value = PV of cash inflows - PV of cash outflows
Net present value = ($6,997,294 + $510,222) - $1,200,000
Net present value = $6,307,516
The closest answer choice is (B) $(532,516).

(Ignore Income Taxes in This Problem