NPV discount rate of 10 percent

Question

Sally Omar is the manager of the office products division of Wallace Enterprises. In this position, her annual bonus is based on an appraisal of return on investment (ROI) measured as Division income ÷ End-of-year division assets (net of accumulated depreciation).

Currently, Sally is considering investing $40,000,000 in modernization of the division plant in Tennessee. She estimates that the project will generate cash savings of $6,180,000 per year for eight years. The plant improvements will be depreciated over eight years ($40,000,000 / 8 years = $5,000,000). Thus, the annual effect on income will be $1,180,000 ($6,180,000 - $5,000,000).

 

Using a discount rate of 10 percent, calculate the NPV of the modernization project. (Round present value factor calculations to 4 decimal places, e.g. 1.2151 and final answer to 0 decimal places, e.g. 125. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Answer 1

NPV = ∑ {Net Period Cash Flow / (1+R)^T} - Initial Investment
R is rate of return

T is number of time periods

Multiply each year's cash flow by the corresponding present value factor to arrive at each year's discounted cash flow. Add the results for each of the 8 years and subtract the initial investment

NPV = ∑ (6,180,000 /(1 +.1)^8) - 40,000,000

NPV = 32,969,000 - 40,000,000

NPV = (7,031,000)