Homework SourseYour firm is contemplating the purchase of a new 1739000 com
Your firm is contemplating the purchase of a new $1,739,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $169,200 at the end of that time. You will be able to reduce working capital by $235,000 (this is a one-time reduction). The tax rate is 34 percent and your required return on the project is 22 percent and your pretax cost savings are $800,950 per year.
At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?
| Your firm is contemplating the purchase of a new $1,739,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $169,200 at the end of that time. You will be able to reduce working capital by $235,000 (this is a one-time reduction). The tax rate is 34 percent and your required return on the project is 22 percent and your pretax cost savings are $800,950 per year. |
Solution
Calculation of NPV
Year
1
2
3
4
5
Savings
800,950
800,950
800,950
800,950
800,950
Dep
(347,800)
(347,800)
(347,800)
(347,800)
(347,800)
Income
453,150
453,150
453,150
453,150
453,150
Less: tax
(154,071)
(154,071)
(154,071)
(154,071)
(154,071)
Income After Tax
299,079
299,079
299,079
299,079
299,079
Dep
347,800
347,800
347,800
347,800
347,800
Cash Flows
646,879
646,879
646,879
646,879
646,879
Salvage Value after tax
111,672
Net Cash Flows
646,879
646,879
646,879
646,879
758,551
PVF
0.820
0.672
0.551
0.451
0.370
Present value of Inflows
530,441
434703
356430
291742
280664
PV of Inflows = 1893,980
Less: Initial Investment 1739000
Add: WORKING Capital Release 235,000
Less: Working Capital re introduced at year end 5 = 235000*.370 = 86,950
NPV = 303,030
Hence, 5
| Year | 1 | 2 | 3 | 4 | 5 |
| Savings | 800,950 | 800,950 | 800,950 | 800,950 | 800,950 |
| Dep | (347,800) | (347,800) | (347,800) | (347,800) | (347,800) |
| Income | 453,150 | 453,150 | 453,150 | 453,150 | 453,150 |
| Less: tax | (154,071) | (154,071) | (154,071) | (154,071) | (154,071) |
| Income After Tax | 299,079 | 299,079 | 299,079 | 299,079 | 299,079 |
| Dep | 347,800 | 347,800 | 347,800 | 347,800 | 347,800 |
| Cash Flows | 646,879 | 646,879 | 646,879 | 646,879 | 646,879 |
| Salvage Value after tax | 111,672 | ||||
| Net Cash Flows | 646,879 | 646,879 | 646,879 | 646,879 | 758,551 |
| PVF | 0.820 | 0.672 | 0.551 | 0.451 | 0.370 |
| Present value of Inflows | 530,441 | 434703 | 356430 | 291742 | 280664 |
