Stop Slicing Inc. is evaluating the purchase of a new computer system. System A
ID: 2810694 • Letter: S
Question
Stop Slicing Inc. is evaluating the purchase of a new computer system. System A will require
an initial outlay of $100,000. Cash inflows are expected to be $10,000 at the end of year one,
$20,000 at the end of year two, $30,000 at the end of year three, $40,000 at the end of year
four, and $50,000 at the end of year five. System B will require an initial outlay of $50,000,
with expected cash inflows of $10,000 at the end of year one, $20,000 at the end of year
two, $15,000 at the end of year three, and $20,000 at the end of year four. The firm has a
10% required rate of return (the "hurdle rate"). Based upon net present value, and assuming
only one system is needed, which computer system should SSI acquire
Explanation / Answer
Calculation of Net Present Value [NPV]
Net Present Value [NPV] – System A
Net Present Value [NPV] = Present Value of Annual cash flows – Initial Investment
Year
Net Cash Flow
Present Value Factor at 10%
Present Value of Net Cash Flow
1
10,000.00
0.90909
9,090.91
2
20,000.00
0.82645
16,528.93
3
30,000.00
0.75131
22,539.44
4
40,000.00
0.68301
27,320.54
5
50,000.00
0.62092
31,046.07
1,06,525.88
Present value of net cash flow
1,06,525.88
Less amount to be invested
1,00,000.00
Net Present Value [NPV]
6,525.88
Net Present Value [NPV] – System B
Net Present Value [NPV] = Present Value of Annual cash flows – Initial Investment
Year
Net Cash Flow
Present Value Factor at 10%
Present Value of Net Cash Flow
1
10,000.00
0.90909
9,090.91
2
20,000.00
0.82645
16,528.93
3
15,000.00
0.75131
11,269.72
4
20,000.00
0.68301
13,660.27
50,549.83
Present value of net cash flow
50,549.83
Less amount to be invested
50,000.00
Net Present Value [NPV]
549.83
DICISION
Stop Slicing Inc should acquire SYSTEM A Since it has a higher Net Present Value of $6,525.88 as compared to the Net Present Value of SYSTEM B which has a Net Present Value of $549.83
Year
Net Cash Flow
Present Value Factor at 10%
Present Value of Net Cash Flow
1
10,000.00
0.90909
9,090.91
2
20,000.00
0.82645
16,528.93
3
30,000.00
0.75131
22,539.44
4
40,000.00
0.68301
27,320.54
5
50,000.00
0.62092
31,046.07
1,06,525.88