A company is contemplating buying a $300,000 security system. The system is sele

Question

A company is contemplating buying a $300,000 security system. The system is selected after a a group within the company spent $20,000 studying similar security systems last year. The new system will save them $175,000 each year before taxes. Working capital would also be reduced by $75,000 in year 1, and $20,000 in year 2, which are permanent reductions. Three years later, the scrap value of the security system would be $100,000. Regulations require the system be depreciated according to a MACRS 3-year schedule. Assume the firm’s discount rate is 10 percent and the tax rate is 30 percent.

What is the NPV and the IRR of this new project?

Potential Recovery Percentages are listed below:

Year

            3 years            5 years          7 years               10 years

1          16.5%              10%                 7%                   5%

2          22.5%              16%                 12.5%              9%

3          7.5%                9.5%                8.5%                7%

4          3.5%                6%                   6.5%                6%

5                                  5.5%                4.5%                4.5%

6                                  3%                   4.5%                3.5%

7                                                          4.5%                3.5%

8                                                                                  3.5%

9                                                                                  3.5%

10                                                                                3%

11                                                                                1.5%

Explanation / Answer

MACRS annual Net Savings After tax Year Depreciation Savings Tax @30% EAT Cashinflows 1 49500 175000 125500 37650 87850 137350 2 67500 175000 107500 32250 75250 142750 3 22500 175000 152500 45750 106750 129250 Initial Working Scrap Cash from Total pv factor Present Year investent Capital Value Operation cashflow at 10% Value 0 -300000 -300000 1.000000 -300000 1 -75000 137350 62350 0.909091 56681.818 2 -20000 142750 122750 0.826446 101446.28 3 100000 129250 229250 0.751315 172238.92 Total 30367.017 Present Value of the project at 10%: $30,367.02 Total Present Value using discount rate of:- Year cashflow 13% 14.00% 14.63% 15.00% 16.00% 17.00% 0 -300000 -300000.00 -300000.00 -300000.00 -300000.00 -300000.00 -300000.00 1 62350 55176.99 54692.98 54391.68 54217.39 53750.00 53290.60 2 122750 96131.26 94452.14 93414.34 92816.64 91223.25 89670.54 3 229250 158881.75 154737.22 152193.96 150735.60 146870.77 143136.95 Total 10190.00 3882.34 -0.02 -2230.38 -8155.98 -13901.91 At discount rate of 14.63% present value is 0. So IRR = 14.63%

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