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Payback period and NPV

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Philadelphia Physicians is considering the replacement of an old billing system with new software that should save $5,000 per year in net cash operating costs. The old system has zero disposal value, but it could be used for the next 12 years. The estimated useful life of the new software is 12 years, and it will cost $25,000. The minimum desired rate of return is 10%.

1. What is the payback period?
2. Compute the net present value (NPV).
3. Management is unsure about the useful life. What would be the NPV if the useful life were (a) 5 years instead of 12 or (b) 20 years instead of 12?
4. Suppose the life will be 12 years, but the savings will be $3,500 per year instead of $5,000. What would be the NPV?
5. Suppose the annual savings will be $4,000 for eight years. What would be the NPV?

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The solution explains the calculation of payback period and NPV

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1. Payback period is the time taken to recover the initial investment. In this case the initial investment
is $25,000 and we recover $5,000 each year in savings. Therefore it will take 25,000/5,000=5 years
to recover the initial investment. The payback period is 5 years.

To compute the NPV, we need to calculate the present value ...

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