Question

A new furnace for your small factory will cost $29,000 and a year to install, will require ongoing maintenance expenditures of $1,200 a year. But it is far more fuel-efficient than your old furnace and will reduce your consumption of heating oil by 2,800 gallons per year. Heating oil this year will cost $2 a gallon; the price per gallon is expected to increase by $0.50 a year for the next 3 years and then to stabilize for the foreseeable future. The furnace will last for 20 years, at which point it will need to be replaced and will have no salvage value. The discount rate is 6%.

Answer 1

Answer:

Net present value is $61,058.

Step-by-step explanation:

Net present value is the difference between present value of cash inflows and the present value cash outflows over the period of time. NPV method is used in capital budgeting to analyze profitability of the project.

Less: initial cost is $29,000

Add: Year 1: Cost saving due to new furnace is $5,600 (2,800 oil gallons * $ 2 per gallon)

Year 2: Cost saving due to new furnace is $7,000 (2,800 oil gallons * $ 2.50 per gallon)

Year 3- 20: Cost saving due to new furnace is $8,400 (2,800 oil gallons * $ 3 per gallon)

Less : Maintenance expenditure is $1,200

The furnace will benefit for 20 years and the price per gallon will increase by $0.50 year.

The annuity factor is applied at discount factor of 6% and then present value of each cash inflow and outflow is calculated. The net present value is $61,058.