Your employer is evaluating the purchase of software for controlling security in
ID: 2880172 • Letter: Y
Question
Your employer is evaluating the purchase of software for controlling security in its network from two different sources - Company A or Company B. Analysis of the costs and benefits for Company A are as follows: Initial cost of Company A’s software is $300,000. Estimated savings for Company A’s software are: Year 1 - $150,000, Year 2 - $150,000, Year 3 - $100,000, Year 4 - $100,000, Year 5 - $100,000. A major upgrade costing $$100,000 will have to be purchased in Year 2 for Company A. Analysis of the costs and benefits for Company B’s software are as follows: Initial cost of Company B’s software is $315,000. Estimated savings for Company B’s software are: Year 1 - $150,000, Year 2 - $150,000, Year 3 - $100,000, Year 4 - $100,000, Year 5 - $100,000. A major upgrade costing $100,000 will have to be purchased in Year 4 for Company B. Your employer’s discount rate is 12%. What is the Net Present Value for buying software from Company A and from Company B? (Use a spreadsheet) . Based on your calculations, which company’s software will you recommend? Explain your answer.
Explanation / Answer
NPV = {Net Period Cash Flow/(1+R)^T} - Initial Investment
- where R is the rate of return, and T is the number of time periods.
For company A
NPV = {$150,000/(1+.12)^1} + {$50,000/(1+.12)^2} + {$100,000/(1+.12)^3} +{$100,000/(1+.12)^3} + {$100,000/(1+.12)^3}- $300,000
For company B
NPV = {$150,000/(1+.12)^1} + {$150,000/(1+.12)^2} + {$100,000/(1+.12)^3} +{$0 /(1+.12)^3} + {$100,000/(1+.12)^3}- $315,000
Calculating NPV in Excel
cell B1 in the "rate" field.
cell B2 in the first "value" field only if the investment occurs at the end of the first period.
cells B3, B4 ,B5,B6 in the next 3 value fields.
Upgrade value is to be deducted.
formula "=NPV(B1,B2,B3,B4,B5,B6)" into cell B7
=607375.82 for company A
=621811.04 for company B
we will recommend company B.
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