Basic Net Present Value Analysis

Jonathan Butler, process engineer, knows that the acceptance of a new process design will depend on its economic feasibility. The new process is designed to improve environmental performance. On the negative side, the process design requires new equipment and an infusion of working capital. The equipment will cost $1,200,000, and its cash operating expenses will total $270,000 per year. The equipment will last for 7 years but will need a major overhaul costing $120,000 at the end of the fifth year. At the end of 7 years, the equipment will be sold for $96,000. An increase in working capital totaling $120,000 will also be needed at the beginning. This will be recovered at the end of the 7 years.

On the positive side, Jonathan estimates that the new process will save $400,000 per year in environmental costs (fines and cleanup costs avoided). The cost of capital is 12%.

Required:

Question Content Area

Two present value tables are provided: Present Value of a Single Amount and Present Value of an Annuity. Use them as directed in the problem requirements.

Question Content Area

1. Prepare a schedule of cash flows for the proposed project. (Assume that there are no income taxes.) If an amount is negative or an outflow, first enter a minus sign (-).

Line Item Description	Amount
Year 0
EquipmentEquipment operating costsRevenuesSalvage valueTotalEquipment	$Equipment
Operating expensesRevenuesSalvage valueTotalWorking capitalWorking capital	Working capital
Equipment operating costsRecovery of working capitalRevenuesSalvage valueTotalTotal	$Total
Years 1-7
Cost savingsEquipmentExpensesTotalWorking capitalExpenses	$Expenses
EquipmentEquipment operating costsSalvage valueTotalWorking capitalEquipment operating costs	Equipment operating costs
EquipmentRecovery of working capitalSalvage valueTotalWorking capitalTotal	$Total
Year 5
EquipmentOverhaulSalvage valueTotalWorking capitalOverhaul	$Overhaul
Year 7
EquipmentExpensesSalvage valueTotalWorking capitalSalvage value	$Salvage value
EquipmentExpensesRecovery of working capitalTotalWorking capitalRecovery of working capital	Recovery of working capital
EquipmentExpensesRevenuesTotalWorking capitalTotal	$Total

Question Content Area

2(a) Compute the NPV of the project. For discount factors, use the tables shown in Present Value Tables. Round the present value calculation and your final answer to the nearest whole dollar. If an amount is negative, first enter a minus sign (-). The NPV of the project is fill in the blank 1 of 1$.

2(b) Should the new process design be accepted?

YesNoNo

, the new process design

shouldshould notshould not

be accepted.