Question

Sally Omar is the manager of the office products division of Runner 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 $43,864,000 in modernization of the division plant in Tennessee. She estimates that the project will generate cash savings of $6,057,000 per year for 8 years. The plant improvements will be depreciated over 8 years ($43,864,000 ÷ 8 years = $5,483,000). Thus, the annual effect on income will be $574,000 ($6,057,000 - $5,483,000)

Using a discount rate of 11 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

Answer:

NPV of the modernization project = ($12,694,072)

Calculations are as below:

Initial Investment =$43,864,000

As there is no information on tax given, assumption is that there is no tax.

Cash flow per year = Annual effect of income + depreciation = $574,000 + $5,483,000 = $6,057,000

Present Value Interest Factors for a One-Dollar Annuity Discounted at 11% for 8 Periods = 5.1461

Present value of cash inflows = $6,057,000 * 5.1461 = 31,169,927.70

NPV = Present value of cash inflows - Initial Investment = $31,169,927.70 - $43,864,000 = ($12,694,072)

(Rounded off 0 decimal place)