The Johnson Research Organization, a nonprofit organization that does not pay ta

Question

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 A.8. Investment (outflow at time 0) $ 6,950,000 Periodic operating cash flows: Annual cash savings because outside laboratories are not used 1,420,000 Additional cash outflow for people and supplies to operate the equipment 220,000 Salvage value after seven years, which is the estimated life of this project 420,000 Discount rate 6 % Required: Calculate the net present value of this decision. (Round PV factor to 3 decimal places.) Should the organization buy the equipment? Yes No

Explanation / Answer

Solution:

Since NPV is positive, Prganization should buy the equipment

Wowrking Note:

- Annaul cash savings will be cash inflow for the prject hence will increase the total inflow.

- Extra cost of $220,000 will be entered as negative since it decreases the overall cash inflow.

- Salvage value after 7 years is a pure inflow hence will be taken in consideration

Calculation of Net Present value Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Annual Cash Savings 1,420,000 1,420,000 1,420,000 1,420,000 1,420,000 1,420,000 1,420,000 Addl Cash Outflow -220,000 -220,000 -220,000 -220,000 -220,000 -220,000 -220,000 Salvage Value 420,000 Net Cash Inflow/ (Outflow) 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 1,620,000 PV factor for $1 at end of year 0.943 0.890 0.840 0.792 0.747 0.705 0.665 PV for Net Cash Inflow 1,132,075.47 1,067,995.73 1,007,543.14 950,512.40 896,709.81 845,952.65 1,077,392.52 Total Present value of Cash Inflow 6,978,182 Cash Outflow at Year 0 6,950,000 Net Present Value 28,182

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