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So I think I understand NPV calculations- but I have no idea how they’re calculating $10,000 per year for the 2-year annuity. Can someone help? Thank you so much!
Pole Co. is investing in a machine with a 3-year life. The machine is expected to reduce annual cash operating costs by $30,000 in each of the first 2 years and by $20,000 in year 3. Present values of an annuity of $1 at 14% are
Period 1 0.88
2 1.65
3 2.32
Using a 14% cost of capital, what is the present value of these future savings?
A. $60,800
B. $62,900
C. $59,600
D. $69,500
Answer (B) is correct.
The cost reductions constitute two annuities: a 3-year annuity of $20,000 per year and a 2-year annuity of $10,000 per year. Using a 14% cost of capital and ignoring tax effects, the present value of the future savings can be calculated as follows:
PV of 3-year cash savings: $20,000 × 2.32 = $46,400
PV of 2-year cash savings: $10,000 × 1.65 = 16,500
Net present value $62,900
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