The law firm of Bushmaster Cobra and Asp is considering inve

The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small business computer system. The initial investment will be $50,000. The computer is in the 5-year MACRS category, and the firm\'s tax rate is 34%. The computer system is expected to provide additional revenue of $32,000 per year for the next six years, and to reduce expenses by $7,000 per year for the same period. a) Calculate the net after-tax cash flows from this investment. b) Calculate the net present value of the system, given that the law firm\'s weighted average cost of capital is 12%. c) Should they buy the computer system? Please show all work without table or excel.

Solution

a) calcultaion of net afer tax cash flows: ($)

Additional Revenue 32000

Add: Decrease in expenses 7000

Less: depreciation ($50000/5) (10000)

Cash Flows 29000

Less : Tax @ 34% (9860)

Net Cash Flows 19140

Add: Depreciation 10000

Net Operating Cash Flows 29140

b) NPV = PV of cash inflow - PV of cash outflow

= [29140*0.8929 +29140*0.7972 + 29140*0.7118 + 29140*0.6355 +29140*0.5674] - 50000 = 55043.18

c) Since NPV is positive computer should be bought.