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Yusuf is considering installing a new energy-efficient lighting in his firm’s warehouse. The installation will cost...

Yusuf is considering installing a new energy-efficient lighting in his firm’s warehouse. The installation will cost $300,000, and he estimates total savings of $75,000 per year. The lights will depreciate evenly over five years, at which point they must be replaced. The cost of capital is 7% per year. What do the NPV and EVA rules indicate about whether Yusuf should install the lights?

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Answer #1
NPV of the installation
Intial Cost+PV of savings for 5 yrs.at 7% Cost of capital
ie. -300000+(75000*4.10020)        (P/A,i=7%,n=5)
7515
As NPV is POSITIVE, it will add value to the firm .
Hence installation is recommended.
Economic Value Added approach:
EVA per year =Economic benefits ,ie.net of depreciation -(initial investment*Cost of capital)
ie. (75000-(300000/5))-(300000*7%)=
-6000
As per EVA approach, installation does not add value
& hence not recommended
The difference is due to the depreciation charge in EVA method
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