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Your firm has the option of making an investment in new software that will cost $130,000 today and is estimated to provide the following savings: $35000, $50000, $45000, $25000, $15000 for year 1 through year 5. Should the firm make this investment if it requires a minimum annual return of 9% on all investments?

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Answer:

Since the net present value from the cash flow projections is positive, therefore the investment is making return of more than 9% and hence the project shall be accepted.

Explanation:

We will calculate the net present value of the cash flows given in the question by using the minimum rate of 9% and if the net present value is positive then the investment shall be made  and if the net present value is negative then the investment shall not be made.

Year         Cash flows                Present value is 9%

0              ($130,000)                ($130,000)        

1               $35,000                   $32,110.09

2              $50,000                   $42,084

3              $45,000                   $34,748.26

4              $25,000                   $17,710.63

5              $15,000                    $9,748.97

 Net present value                  $6,401.95

Since the net present value from the cash flow projections is positive, therefore the investment is making return of more than 9% and hence the project shall be accepted.

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