Suppose that you have a chance to buy some new computer equipment and software t
ID: 1177874 • Letter: S
Question
Suppose that you have a chance to buy some new computer equipment and software that will add to your future profits. It will take a year to have the package designed to your needs, installed, tested and your personnel trained to use it. After that, it will add to your profits for the following 5 years until you expect to change your hardware over again. The project is expected to make you:
Year
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Increase in Profits
0.00
1,000,000
2,000,000
2,000,000
1,000,000
1,000,000
Present Value
Notice that the project will increase your profits a total of $7 million dollars, BUT that benefit is spread over a 6 year period while the cost is paid now. Find the present value for each year if the interest rate is 6% and then add them together for the total present value of future revenue.
Total PV = ?
If the price of the software is $5 million is it profitable to buy the software?
Year
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Increase in Profits
0.00
1,000,000
2,000,000
2,000,000
1,000,000
1,000,000
Present Value
Explanation / Answer
Year
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Increase in Profits
0.00
1,000,000
2,000,000
2,000,000
1,000,000
1,000,000
Present Value
0
943,396
1,779,993
1,679,238.6
792,093.7
747,258.2
Total present value of future revenue : 5,941,980
Since present value of future revenue is greater than $5 million dollar it is profitable to buy software
Use the formula PV = FV/(1+r/100)^n-1
r: rate of interest
n: nth year eg .1st , 2nd , 3rd and so on..
Year
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Increase in Profits
0.00
1,000,000
2,000,000
2,000,000
1,000,000
1,000,000
Present Value
0
943,396
1,779,993
1,679,238.6
792,093.7
747,258.2
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