Present Generator New Generator Purchase cost new $16,000 $20,000 Remaining book
ID: 2541049 • Letter: P
Question
Present Generator
New Generator
Purchase cost new
$16,000
$20,000
Remaining book value
$9000
Overhaul needed now
$8000
Annual cash operating cost
$12,500
$7500
New economic life
8 years
10 years
Salvage value now
$4000
Salvage value in 8 years
$3000
$6000
Salvage value in 10 years
0
$1000
If the hospital keeps and overhauls its present generator, then the generator will be usable for eight more years. If a new generator is purchased, it will be used for eight years until a new hospital building is opened. The new generator would be diesel-powered resulting in a substantial reduction in annual operating costs as shown above.
The hospital computes depreciation on a straight-line basis. All purchases are evaluated using a 16% discount rate.
Required:
Determine the net present value for each option.
What option would you advise be selected and why?
Present Generator
New Generator
Purchase cost new
$16,000
$20,000
Remaining book value
$9000
Overhaul needed now
$8000
Annual cash operating cost
$12,500
$7500
New economic life
8 years
10 years
Salvage value now
$4000
Salvage value in 8 years
$3000
$6000
Salvage value in 10 years
0
$1000
Explanation / Answer
Answer-
NPV(net present value ) is the difference between the amount of cash outflow and cash inflow over a particularized period.It uses interest/discount factor while considreing calcutiong profitablity of a capital project.
New generator option is better than present generator as it will result in less cost as per calculation showed above.
*There is no revenue mention in question hence decision has been taken on the cost basis.
Present Generator End of year N.C.F. Dis Rate @0.16 Present Value 1 2 3 4=2*3 1 12,500 0.862 10,776 2 12,500 0.743 9,290 3 12,500 0.641 8,008 4 12,500 0.552 6,904 5 12,500 0.476 5,951 6 12,500 0.410 5,131 7 12,500 0.354 4,423 8 9,500(salvage value -3,000) 0.305 2,898 9 - 10 - Total Cash Outflow 53,380 Add: Overhaul 8,000 Working Capital - 8,000 8,000 NPV $ 61,380