Question

Suppose Hunter Valley is deciding whether to purchase new accounting software. The payback for the $30,050 software package is two years, and the software’s expected life is three years. Hunter Valley’s required rate of return for this type of project is 10.0%. Assuming equal yearly cash flows, what are the expected annual net cash savings from the new software?

Short answer

Annual net cash saving is $15,025.

Step-by-step solution

Definition of Annual Cash Flows

The yearly cash inflows within the business entity are defined as annual cash flows. These inflows are not adjusted with the depreciation, amortization and interest expenses.

Expected annual net cash savings from the new software

The business entity will cover the initial investment in the first two years and save cash in the last year, i.e., 3^rd year. Also, the cash flows each year is equal. Therefore, the annual cash net saving will be:

$\begin{array}{rcl}\mathit{A}\mathit{n}\mathit{n}\mathit{u}\mathit{a}\mathit{l}\mathbf{}\mathit{n}\mathit{e}\mathit{t}\mathbf{}\mathit{c}\mathit{a}\mathit{s}\mathit{h}\mathbf{}\mathit{s}\mathit{a}\mathit{v}\mathit{i}\mathit{n}\mathit{g}& \mathbf{=}& \frac{\mathbf{I}\mathbf{n}\mathbf{i}\mathbf{t}\mathbf{i}\mathbf{a}\mathbf{l}\mathbf{}\mathbf{i}\mathbf{n}\mathbf{v}\mathbf{e}\mathbf{s}\mathbf{t}\mathbf{m}\mathbf{e}\mathbf{n}\mathbf{t}}{\mathbf{P}\mathbf{a}\mathbf{y}\mathbf{b}\mathbf{a}\mathbf{c}\mathbf{k}\mathbf{}\mathbf{p}\mathbf{e}\mathbf{r}\mathbf{i}\mathbf{o}\mathbf{d}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{30}\mathbf{,}\mathbf{050}}{\mathbf{2}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{025}\end{array}$