Question

Square Manufacturing is considering investing in a robotics manufacturing line. Installation of the line will cost an estimated $10.2 million. This amount must be paid immediately even though construction will take three years to complete (years 0, 1, and 2). Year 3 will be spent testing the production line and, hence, it will not yield any positive cash flows. If the operation is very successful, the company can expect after-tax cash savings of $7.2 million per year in each of years 4 through 7. After reviewing the use of these systems with the management of other companies, Square’s controller has concluded that the operation will most probably result in annual savings of $5.4 million per year for each of years 4 through 7. However, it is entirely possible that the savings could be as low as $3.0 million per year for each of years 4 through 7. The company uses a 16 percent discount rate. Use Exhibit A.8.

Required:

Compute the NPV under the three scenarios. (Round PV factor to 3 decimal places. Enter your answers in thousands of dollars. Negative amounts should be indicated by a minus sign.)

Answer 1

Here's the calculation for all 3 scenarios:

Discount Rate (i)	16%
Scenario 1:
Year (n)	1	2	3	4	5	6	7
After tax cash savings (FV)	0	0	0	7200000	7200000	7200000	7200000
PV Factor =" (1+i)" to the power "n" (rounded off to 3 decimal places)	1.16	1.346	1.561	1.811	2.1	2.436	2.826
NPV Formulae = FV/PV factor (Value in $'000s)	0	0	0	3975.704	3428.5714	2955.665	2547.771
Thus, NPV = sum of all 7 years (Value in $'000s)	$12,907.71
Scenario 2:
Year (n)	1	2	3	4	5	6	7
After tax cash savings (FV)	0	0	0	5400000	5400000	5400000	5400000
PV Factor =" (1+i)" to the power "n" (rounded off to 3 decimal places)	1.16	1.346	1.561	1.811	2.1	2.436	2.826
NPV Formulae = FV/PV factor (Value in $'000s)	0	0	0	2981.778	2571.4286	2216.749	1910.828
Thus, NPV = sum of all 7 years (Value in $'000s)	$9,680.78
Scenario 3:
Year (n)	1	2	3	4	5	6	7
After tax cash savings (FV)	0	0	0	3000000	3000000	3000000	3000000
PV Factor =" (1+i)" to the power "n" (rounded off to 3 decimal places)	1.16	1.346	1.561	1.811	2.1	2.436	2.826
NPV Formulae = FV/PV factor (Value in $'000s)	0	0	0	1656.543	1428.5714	1231.527	1061.571
Thus, NPV = sum of all 7 years (Value in $'000s)	$5,378.21