A-14 Present Value Analysis in Nonprofit Organizations The Johnson Research Orga

Question

A-14 Present Value Analysis in Nonprofit Organizations The Johnson Research Organization, a nonprofit organization that does not pay taxes, is considering buying laboratory equipment with an estimated life of seven years so it will not have to use outsiders' laboratories for certain types of work. The following are all of the cash flows affected by the decision: Use Exhibit A8. $5,150,000 Investment (outflow at time 0) Periodic operating cash flows: Annual cash savings because outside laboratories are not used Additional cash outflow for people and supplies to operate the equipment 1,540,000 340,000 540,000 Salvage value after seven years, which is the estimated life of this project Discount rate 15% Required: Calculate the net present value of this decision. (Round PV factor to 3 decimal places.) et present val ue Should the organization buy the equipment? Yes No

Explanation / Answer

Net present Value ( NPV) = Present value of cash inflows - Present value of cash outflows ( including initial cost)

Here cash outflows are : a) Initial cost $ 5,150,000 and b) Annual additional cash outflow = $ 340,000

Present value of Outflow = $5,150,000 + $ 340,000 × 4.160= $6,564,400

For value 4.160 see present value annuity factor table 15% ,time period 7

Next calculate the present value of cash inflows.

Here cash inflows are : a) Annual cash savings 1,540,000 b) Salvage value after 7 years = $ 540,000

Present value of cash inflows = 1,540,000 × 4.160 + 540,000 × 0.376 = $ 6,609,440

For 0.376 see present value table 15% , 7 th period.

NPV = $ 6,609,440 - $6,564,400 = $45,040

Yes the organisation should buy the equipment because net present value is positive i .e. $ 45,040. Positive NPV means the return will be higher than 15% .

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