Question

The warehouse manager at Johnson Cor. is considering installing additional insulation in the warehouse. He estimates that the annual savings would be a reduction in heating cost from the current $16,000 per year to approximately $12,000 per year. Johnson Corp. Desires to earn 12% ROI, and the cost of installing the insulation is expected to be $20,000. How many years does the warehouse have to run in order to justify the insulation project

Answer 1

Answer:

9 years

Explanation:

Note: See the attached excel file for the calculation of the cumulative present value (PV).

Annual cost saving = $16,000 - $12,000 = $4,000

With annual cash saving of $4,000 and 12% return on investment (ROI), the cumulative PV of the cash flow from installing the insulation becomes positive in the 9th year at $1,313.

Since the cumulative PV is positive in the 9th year, that means the discounted payback year is 9th year. Therefore, the warehouse have to run for 9 years in order to justify the insulation project.

Note:

The actual discounted payback period is approximately 8 years and 1 month as calculated below:

Discounted payback period = 8 years and ((129.44/1,442.44) * 12) = 8 years and 1 month.

Download xlsx