Your employer is contemplating installing a new mail ordering system to make com

Question

Your employer is contemplating installing a new mail ordering system to make company operations more efficient and to increase sales. The computerized system will cost $600.000 to purchase. It will cost $100,000 to maintain each year. The system is expected to last eight years with a salvage value of $100,000 at the end of the service period. The new order system will save $ 150.000 in operating costs and bring in additional sales revenue in the amount of $60,000 for each of the next eight years. If your interest rate is 8%. justify the investment using NPW method.

Explanation / Answer

The net present worth (NPW) is the difference between the present worth of all cash inflows and outflows of a project. Since all cash flows are discounted to the present the NPW method is also known as the discounted cash flow technique. This method not only allows the selection of a single project based on the NPW value but also a selection of the most economical project from a list of more than one alternative projects. To find the NPW of a project an interest rate is needed to discount future cash flows. The most appropriate value to use for this interest rate is the rate of return that one can obtain from investing the money somewhere. Alternatively, it can also be the rate that you will be charged if you had to borrow the money. The selection of this rate is a policy decision. In engineering economy this interest rate is known as the minimum attractive rate of return (MARR). In our analyses we will assume that the value of MARR is known. Coming to solution: Inflow of cash every year = 150000+60000-100000 = 140000 NPV = (-600000)+(140000/(1.08^1))+(140000/(1.08^2))+(140000/(1.08^3))+(140000/(1.08^4))+(140000/(1.08^5))+(140000/(1.08^6))+(140000/(1.08^7))+(140000/(1.08^8))+(100000/(1.08^8)) = 258556.3406 > 0 So the investment is a good investment.

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