Payback Period and NPV: Taxes and Straight-Line Depreciation Assume that United

Question

Payback Period and NPV: Taxes and Straight-Line Depreciation

Assume that United Technologies is evaluating a proposal to change the company's manual design system to a computer-aided design (CAD) system. The proposed system is expected to save 9,000 design hours per year; an operating cost savings of $45 per hour. The annual cash expenditures of operating the CAD system are estimated to be $200,000. The CAD system requires an initial investment of $550,000. The estimated life of this system is five years with no salvage value. The tax rate is 35 percent, and United Technologies uses straight-line depreciation for tax purposes. United Technologies has a cost of capital of 14 percent.

(a) Compute the annual after-tax cash flows related to the CAD project.
$Answer

(b) Compute each of the following for the project:

1. Payback period. Round your answer to 2 decimal places.
Answer

years

2. Net present value. (Round answer to the nearest whole number.)
$Answer

Explanation / Answer

(a) Statement showing computation of Annual after Tax Cash flows relating to CAD

(b) 1.Payback period = Initial investment/After tax annual cash inflows

= $550000/$171750

= 3.20

2. NPV = P.V. of cash inflow - P.V. of cash outflow

= $171750*3.433 - $550000

= $39,618

Particulars Amount Savings in operating cost($9000*45) $405000 Less: Cash expenditure $200000 CFBT $205000 Less: Tax @ 35% $71750 Add: Tax savings on depreciation ($550000/5)*35% $38500 CFAT $171750

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