Your firm is contemplating the purchase of a new $794,500 computer-based order e

Question

Your firm is contemplating the purchase of a new $794,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $59,000 at the end of that time. You will be able to reduce working capital by $54,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 30 percent.

Suppose your required return on the project is 9 percent and your pretax cost savings are $209,000 per year. What is the NPV of the project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Suppose your required return on the project is 9 percent and your pretax cost savings are $149,000 per year. What is the NPV of the project? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).)

Your firm is contemplating the purchase of a new $794,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $59,000 at the end of that time. You will be able to reduce working capital by $54,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 30 percent.

Explanation / Answer

Requirement 1:

Depreciation = 794,500/7= 113500

Free cash flow 1-7 year = (209,000-113500)*(1-30%) + 113500= $180350

After tax salvage value = 59,000 -(59,000-0)*30% = 41300

Initial cash flow =- 794,500+54000=-740500

NPV = -740500 + 180350/1.09 + 180350/1.09^2 + 180350/1.09^3 ...............180350/1.09^7 + 41300/1.09^7 -54000/1.09^7 = $160,245.71

Requirement 2:

Depreciation = 794,500/7= 113500

Free cash flow 1-7 year = (149000-113500)*(1-30%) + 113500= $138350

After tax salvage value = 59,000 -(59,000-0)*30% = 41300

Initial cash flow =- 794,500+54000=-740500

NPV = -740500 + 138350/1.09 + 138350/1.09^2 + 138350/1.09^3 ...............138350/1.09^7 + 41300/1.09^7 -54000/1.09^7 = -$51,138.31

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