The Atlantic Medical Clinic can purchase a new computer system that will save $7

Question

The Atlantic Medical Clinic can purchase a new computer system that will save $7,000 annually in billing costs. The computer system will last for eight years and have no salvage value.

Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

Required:

Up to how much should the Atlantic Medical Clinic be willing to pay for the new computer system
if the clinic’s required rate of return is: (Use the appropriate table to determine the discount factor(s).)

            PURCHASE x DISCOUNT FACTOR = PRESENT VAUE

1. 16%  

2. 20%

Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

Explanation / Answer

If the Company's Required Rate of Return is 16% then the PV of $1 for 8 years @16% discounting factors is 4.3436

Hence if the company Saves $7000 annually then the PV for 8 years is =7000*4.3436

= $30,405.20

Hence if the Company's Rate of Return is 16% then it should not pay more than $30,405 for purchasing the computer.

If the Rate of Return expected is 20% then the PV of $1 for 8 years is =3.8372

so the Present Value of $7000 @20% discount factor is = $7000*3.8372

=26,860.40

So Atlantic Medical should not Pay more then $26,860 for the purchase of Computer if required rate of return is 20%.

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