[lrulon]

A company wants to buy a labor-saving piece of equipment. Using the NPV method of capital budgeting, determine the proposal’s appropriateness and economic viability with the following information:

• Labor content is 12% of sales, which are annually $10 million.
• The new equipment will save 20% of labor annually.
• The new equipment will last 5 years.
• The new equipment will cost $200,000.
The discount rate is 10%

Does the labor expense need to be used for theNPV?

[morgaine300]

What you're really looking at is differences between what is currently happening and what will happen with the investment. It sounds like the 12% labor is what is already happening - notice it's "labor-saving" equipment. So I assume the 12% is what they have now.

The new equipment will save them 20% of that. That's the differential that you're looking at. A savings is a negative expense - it's reducing the expense.

When doing a NPV look at everything as a positive or negative. So logically additional revenues are positive and additional expenditures are negatives... but reductions of revenue are also negatives (don't think I've ever seen that though), and reductions in expenses are positives. Does that make sense?

So your 20% reduction in labor is going to be a positive cash flow. You're not literally bringing the cash in, but saving it means you do have that much more cash.