Your firm is contemplating the purchase of a new 1776000 com

Your firm is contemplating the purchase of a new $1,776,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $172,800 at the end of that time. You will be able to reduce working capital by $240,000 (this is a one-time reduction). The tax rate is 32 percent and your required return on the project is 16 percent and your pretax cost savings are $494,000 per year. Requirement 1: What is the NPV of this project? (Click to select) Requirement 2: What is the NPV if the pretax cost savings are $686,150 per year? (Click to select) Requirement 3: At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it? (Click to select)

Solution

Cost of System = $1,776,000
Useful Life = 5 years

Annual Depreciation = Cost of System / Useful Life
Annual Depreciation = $1,776,000 / 5
Annual Depreciation = $355,200

Salvage Value = $172,800
After-tax Salvage Value = $172,800 * (1 - 0.32)
After-tax Salvage Value = $117,504

Initial NWC reduced = $240,000
NWC recovered = $240,000

Answer 1.

Annual OCF = Pretax Cost Saving * (1 - tax) + tax * Annual Depreciation
Annual OCF = $494,000 * (1 - 0.32) + 0.32 * $355,200
Annual OCF = $449,584

NPV = -$1,776,000 + $240,000 + $449,584 * PVA of $1 (16%, 5) - $240,000 * PV of $1 (16%, 5) + $117,504 * PV of $1 (16%, 5)
NPV = -$1,776,000 + $240,000 + $449,584 * 3.274 - $240,000 * 0.476 + $117,504 * 0.476
NPV = -$122,370.08

Answer 2.

Annual OCF = Pretax Cost Saving * (1 - tax) + tax * Annual Depreciation
Annual OCF = $686,150 * (1 - 0.32) + 0.32 * $355,200
Annual OCF = $580,246

NPV = -$1,776,000 + $240,000 + $580,246 * PVA of $1 (16%, 5) - $240,000 * PV of $1 (16%, 5) + $117,504 * PV of $1 (16%, 5)
NPV = -$1,776,000 + $240,000 + $580,246 * 3.274 - $240,000 * 0.476 + $117,504 * 0.476
NPV = $305,417.31

Answer 3.

NPV of this project will be $0 at indifferent point.

NPV = -$1,776,000 + $240,000 + Annual OCF * PVA of $1 (16%, 5) - $240,000 * PV of $1 (16%, 5) + $117,504 * PV of $1 (16%, 5)
0 = -$1,776,000 + $240,000 + Annual OCF * 3.274 - $240,000 * 0.476 + $117,504 * 0.476
0 = -$1,536,000 + Annual OCF * 3.274 - $58,308.10
Annual OCF * 3.274 = $1,594,308.10
Annual OCF = $486,960.32

Annual OCF = Pretax Cost Saving * (1 - tax) + tax * Annual Depreciation
$486,960.32 = Pretax Cost Saving * (1 - 0.32) + 0.32 * $355,200
$486,960.32 = Pretax Cost Saving * 0.68 + $113,664
Pretax Cost Saving * 0.68 = $373,296.32
Pretax Cost Saving = $548,965.18