Greer Law Associates is evaluating a capital investment proposal for new office

Question

Greer Law Associates is evaluating a capital investment proposal for new office equipment for the current year. The initial investment would require the firm to spend $50,000. The equipment would be depreciated on a straight- line basis over five years with no salvage value. The firm's accountant has estimated the before-tax annual cash inflow from the investment to bee $15,000. The income tax rate is 40 percent, and all taxes are paid in the year that the related cash flows occur. The desired after-tax rate of return is 15 percent. All cash flows occur at year's end.
What is the net value of the capital investment proposal?
Should the proposal be accepted? Why or why not?

Explanation / Answer

1 calculation of the net present value of the investment 1 years 1 2 3 4 5 2 before tax annual cash flows 15000 15000 15000 15000 15000 3 depreciation 10000 10000 10000 10000 10000 4 profit ( 2 - 3 ) 5000 5000 5000 5000 5000 5 tax at 40 % 2000 2000 2000 2000 2000 6 profit after tax ( 4 - 5 ) 3000 3000 3000 3000 3000 7 net cash flows ( 6 + 3 ) 13000 13000 13000 13000 13000 8 PVRF at 15 % 0.8696 0.7561 0.6575 0.5718 0.4972 9 present value cash flows ( 7 * 8 ) 11304 9830 8548 7433 6463 10 total present value 43578 11 initial cash outlay 50000 12 net present value ( 10 - 11 ) -6422 depreciation cost of the investment / number of years 50000 / 5 10000 net value of capital investment -6422 the proposal should not be accepted as the net present value is negative

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