Larry’s Lawn Service needs to purchase a new lawnmower costing $8,436 to replace

Question

Larry’s Lawn Service needs to purchase a new lawnmower costing $8,436 to replace an old lawnmower that cannot be repaired. The new lawnmower is expected to have a useful life of 7 years, with no salvage value at the end of that period.

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(a) If Larry’s required rate of return is 12%, what level of annual cash savings must the lawnmower generate to be considered an acceptable investment under the net present value method? (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to 0 decimal place, e.g. 58,971.) Annual cash savings should be $

Explanation / Answer

Soluiton

Larry’s Lawn Service

Cost of new lawnmower = $8,436

Useful life = 7 years

Salvage value = 0

Rate of return = 12%

Under the net present value method, an investment becomes acceptable only when the net present value is equal to more than zero.

Net present value = present value of annual cash inflows – present value of cash outflows

Assume x as the present value of annual cash inflows.

Net present value is x (P/A, 12%, 7) - 8,436 =0

NPV is x (4.5638) – 8,436 =0

4.5638x = 8,436

NPV, x= 8,436/4.5638 = $1,848 (rounded to nearest whole dollar)

Hence, desired annual cash savings = $1,848

Cost of new lawnmower = $8,436

Useful life = 7 years

Salvage value = 0

Rate of return = 18%

Under the net present value method, an investment becomes acceptable only when the net present value is equal to more than zero.

Net present value = present value of annual cash inflows – present value of cash outflows

Assume x as the present value of annual cash inflows.

Net present value is x (P/A, 18%, 7) - 8,436 =0

NPV is x (3.8115) – 8,436 =0

3.8115x = 8,436

NPV, x= 8,436/3.8115 = $2,213 (rounded to nearest whole dollar)

Hence, desired annual cash savings = $2,213

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