I'm trying to to understand the fundamental concept of this question. I understand the concept of NPV and and how annuity calculation comes into play of calculating NPV but I cannot wrap my head around UNDERSTANDING this question as a whole, even after looking at the solution.
Para Co. is reviewing the following data relating to an energy saving investment proposal:
Residual at the end of 5 years $10,000
Present ‘value of an annuity of 1 at 12% for 5 years 3.60
Present ‘.value of 1 due in 5 years at 12% 0.57
What would be the annual sayings needed to make the investment realize a 12% yield?
You will be spending $50,000 now. So, to realize a 12% investment yield, you want to make sure that the present value of the residual value (at a 12% rate) plus the present value of whatever the annual savings will be (at a 12% rate) will equal the initial $50,000 cost.
Therefore $50,000 = Present Value of Residual Value + Present Value of Annual Savings
Present Value of Residual Value = Residual Value * PV Factor
Present Value of Residual Value = $10,000 * 0.57
Present Value of Residual Value = $5,700
$50,000 = $5,700 + Present Value of Annual Savings
Present Value of Annual Savings = 50,000 – 5,700 = $44,300
Now that we know what the present value of the annual savings is, we need to determine what the annual savings actually is:
Present Value of Annual Savings = Annual Savings * PV Annuity Factor
$44,300 = Annual Savings * 3.6