Example of npv method, Finance Basics

Example of NPV Method

Resolution limited intends to purchase a machine worth Shs.1, 500,000 that will have a residue value Shs.200,000 after 5 years helpful life. The saving in cost resulting from the utilize of this machine are as:

                                                Shs.

                   Year 1                  800,000

                   Year 2                  350,000

                   Year 3                       -

                   Year 4                  680,000

                   Year 5                  775,000

By using NPV method, inform the company where this machine should be purchased whether the cut off rate is 14 percent and acceptable saving in cost is 12 percent of the cost of the investment.

Solution

Year

1

2

3

4

5

Saving

Scrap value

Total amount

800,000

          -

800,000

350,000

          -

350,000

-

       -

-

680,000

          -

680,000

775,000

200,000

975,000

NPV = 800,000 / (1.14) + 350,000 / (1.14)2 + 680,000 / (1.14)4 +975,000 / (1.14)5 - 1,500,000

= 1,880,067.1 - 1,500,000

= 380,067.07

Return        = (380,067.0/1,500,000) * 100         

                   = 25.337% > 12% therefore invest.

NB: By assuming that the salvage will be realized.

Posted Date: 1/31/2013 12:52:23 AM | Location : United States







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