Net Present Value Method - Example
Jeremy limited wishes to expand its output by purchasing a new machine worth 170,000 and installation costs are estimated at 40,000/=. In the 4th year, this machine will call for an overhaul to cost 80,000/=. Its expected inflows are:
Shs.
Year 1 60,000
Year 2 72,650
Year 3 35,720
Year 4 48,510
Year 5 91,630
Year 6 83,715
This company can raise finance to purchase machine at 12% interest rate.
Compute NPV and advise management accordingly.
Solution
Shs.
Cost of machine at present value 170,000
Installation cost 40,000
210,000
Overhaul cost in the 4^{th} year = 80,000
Discounting factor = (1.12)4
Consequently present value = 80,000/(1.12)^{4}
= Shs.50, 841.446
Sum present value of investment = 260,841.45
P_{V} inflows = 60,000 / (1.12) + 72,650 / (1.12)^{2} + 35,720 / (1.12)^{3} +48,510 / (1.12)^{4} +91,630 / (1.12)^{5} +83,715 / (1.12)^{6}
Consequently:
NPV = 262,147.28 - 260,841.45
NPV = 1,305.83
The NPV is positive and I would inform the management to invest.