X Company is planning to drop a department that has shown a $11,000 loss in each

Question

X Company is planning to drop a department that has shown a $11,000 loss in each of the last 3 years. If the department is dropped, three things will happen: 1) the annual loss will be avoided, 2) some equipment will be sold immediately for $17,000, 3) sales of another product will be increased, contributing $1,000 to annual profits. Assuming a 7 year time horizon and a discount rate of 5%, what is the net present value of dropping the department?

Can someone explain the answer.

Thanks for help!!

Explanation / Answer

Net present value of dropping the department is as shown below:

Note: Loss which will not occur later will notb have any impact on present value.

Dropping department Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Total Equipment sold $17,000 $17,000 Increase in profits 1,000 1,000 1,000 1,000 1,000 1,000 1,000 $7,000 Net cash flow (a) $17,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $24,000 Life 7 years Rate of Return is 5% Present Value factor (b) 1 0.952 0.907 0.864 0.823 0.784 0.746 0.711 Present Value of Net Cash flow (a*b) 17,000.00 952.38 907.03 863.84 822.70 783.53 746.22 710.68 22,786.37

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