Allen College has a telephone system that is in poor condition. The system can be either overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives: Allen College uses a 12% discount rate and the total cost approach to net present value analysis. Both alternatives are expected to have a useful life of eight years. The net present value of the alternative of overhauling the present system is closest to:
A)($238,232)
B)($108,000)
C)($228,232)
D)($232,272)

Question

Allen College has a telephone system that is in poor condition. The system can be either overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:  Allen College uses a 12% discount rate and the total cost approach to net present value analysis. Both alternatives are expected to have a useful life of eight years. The net present value of the alternative of overhauling the present system is closest to:
A)($238,232) 
B)($108,000) 
C)($228,232) 
D)($232,272)

Quizplus · Accepted Answer

Based on the data provided in the table, the net present value for overhauling the current system is calculated as follows:

Initial Investment = $450,000
Annual Cash Inflows = $77,000
Annual Cash Outflows = $38,000
Year 0:
PV of Initial Investment = -$450,000
Year 1-8:
PV of Cash Inflows = $77,000 x PVIFA(12%,8) = $397,768
PV of Cash Outflows = $38,000 x PVIFA(12%,8) = -$197,536
Net Present Value = PV of Inflows + PV of Outflows + PV of Initial Investment
= $397,768 - $197,536 - $450,000
= -$249,768

Therefore, the net present value for overhauling the current system is -$249,768, which is closest to choice C ($228,232). Therefore, the best choice would be to replace the system with a new one.

Allen College Has a Telephone System That Is in Poor