A new inventory management system for ABC Company could be developed at a cost of $200,000. The estimated net operating costs and estimated net benefits over six years of operation would be:
Year Estimated Net Operation
Estimated NetBenefits
0 200,000 0
1 7,0000 $ $52,000
2 9,400 $68,000
3 11,0000 $82,000
4 14,000 $115,000
5 15,000 $120,000
6 16,000 $ $120,000
a. What would the payback period be for this investment? Would it be a good or bad investment? Why?
b. What is the ROI for this investment?
c. Assuming a 12% discount rate, what is this investment NPV?
asas
vvcb
knl
To determine the answers to the questions, we need to calculate the payback period, ROI (Return on Investment), and NPV (Net Present Value). Here's how you can calculate each:
a. Payback Period:
The payback period is the time it takes for the initial investment to be recouped. It can be calculated by adding up the net benefits until they equal or exceed the initial investment cost. In this case, the payback period calculation would be as follows:
Year 0: - $200,000
Year 1: + $52,000
Year 2: + $68,000
Year 3: + $82,000
Year 4: + $115,000
Year 5: + $120,000
Year 6: + $120,000
To calculate the payback period, we need to determine the year when the accumulated net benefits equal or exceed the initial investment. From the given data, we can see that the investment is recouped during Year 4:
Year 0: - $200,000
Year 1: - $200,000 + $52,000 = - $148,000
Year 2: - $148,000 + $68,000 = - $80,000
Year 3: - $80,000 + $82,000 = + $2,000
Year 4: + $2,000 + $115,000 = + $117,000
Since the investment is recouped within four years, the payback period is four years.
Determining whether it is a good or bad investment solely based on the payback period can be subjective. A shorter payback period indicates a quicker return on investment, which is generally considered favorable. However, it does not consider the profitability beyond the payback period, so additional evaluation methods like ROI and NPV should be considered.
b. ROI (Return on Investment):
ROI measures the profitability of an investment relative to its cost. It is calculated by dividing the net benefits by the initial investment and expressing it as a percentage.
ROI = (Net Benefits / Initial Investment) * 100
Using the data provided, the ROI can be calculated at the end of Year 6:
ROI = ($120,000 / $200,000) * 100 = 60%
A 60% ROI indicates that the investment generated a return of 60% of the initial investment amount.
c. NPV (Net Present Value):
NPV calculates the present value of future net cash flows, considering the time value of money. To calculate NPV, we need to discount the estimated net benefits at a given discount rate over the six-year period. In this case, we will assume a 12% discount rate.
The NPV calculation includes the initial investment cost as a negative cash flow at time 0 and the net benefits for each year discounted to their present values. The formula to calculate NPV is as follows:
NPV = (Net Benefits at Year 1 / (1 + Discount Rate)^1) + (Net Benefits at Year 2 / (1 + Discount Rate)^2) + ...
Using the provided data and a 12% discount rate, the NPV calculation is as follows:
NPV = (-$200,000 / (1 + 0.12)^0) + ($52,000 / (1 + 0.12)^1) + ($68,000 / (1 + 0.12)^2) + ($82,000 / (1 + 0.12)^3) + ($115,000 / (1 + 0.12)^4) + ($120,000 / (1 + 0.12)^5) + ($120,000 / (1 + 0.12)^6)
Calculating this equation, we find:
NPV = -$200,000 + $46,428 + $54,467 + $55,982 + $71,459 + $70,763 + $62,451
NPV = $161,550
Since the calculated NPV is positive ($161,550), this investment is considered good as it signifies that the project would generate a positive value after discounting the cash flows.