Question

An engineer proposes to buy a machine for $1,200,000 today that will save $500,000 in labor costs at the end of each of the next 3 years. If the company demands a 12% retum on investments such as this, what is the net present worth (NPW) of the proposal? Should it be funded?

Answer 1

Formula to calculate Net present worth (NPW) of Investment

Net present worth (NPW) = Cost saving of year 1/ (1+ r) ^1 + Cost saving of year 2/ (1+r) ^2 + Cost saving of year 3/ (1+ r) ^3 – Initial Investment (cost of machine)

Where r is the requited rate of return on investment = 12%

Therefore,

NPW = $500,000/ (1+0.12) ^1 + $500,000/ (1+0.12) ^2 + $500,000/ (1+0.12) ^3 - $1,200,000

= $446,428.57 + $398,596.94 + $355,890.12 -$1,200,000

= $1,200,915.63 - $1,200,000

NPW = $915.63

The Net present Worth (NPW) of the proposal is $915.63, as the NPW is positive therefore the proposal should be funded.