The management of Kimco is evaluating the possibility of replacing their large m

Question

The management of Kimco is evaluating the possibility of replacing their large mainframe computer with a modern network system that requires much less office space. The network would cost $500,000 (including installation costs) and would save $125,000 per year in net cash flows (accounting for taxes and depreciation) over the next five years due to efficiency gains. The mainframe has a remaining book value of $50,000 and would be immediately donated to a charity for the tax benefit. Kimco’s discount rate is 10% and its tax rate is 40%. On the basis of NPV, should management install the network system? (Work must be shown for credit)

Explanation / Answer

Answer:

Sum of PV = 473,848.35

Out flows

Cost = - 500000

Inflow from mainframe = (-salvage+book value )*tax

= 20,000

NPV of project = (6151.65)

Hence management should not install network system.

Assumption network system value after 5 years is zero.

Inflow Rate 0.10 Years 1 2 3 4 5 CF 125000.00 125000.00 125000.00 125000.00 125000.00 Discounting factor 113636.36 103305.79 93914.35 85376.68 77615.17

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