The president of Real Time Inc. has asked you to evaluate the proposed acquisiti

Question

The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $40,000, and it falls in the MACRS 3-year class. The applicable depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. Purchase of the computer would require an increase in accounts payable of $2,000. The computer would have an EBT & Depreciation of $15,000. The computer is expected to be used for three years and then sold for $25,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent.

Refer to Real Time Inc. What is the total value of the terminal year non-operating cash flows at the end of Year 3?

Explanation / Answer

Risk-adjusted NPV

Time lines:

Project A

0 1 2 3 Periods

k = 12%

CFs A -5,000 2,000 2,500 2,250

NPV A = ?

Project B

0 1 2 3 Periods

k = 14%

CFs B -5,000 3,000 2,600 2,900

NPV B = ?

Project A: k Average risk = 12%.

Project B: k High risk = 12% + 2% = 14%.

Tabular solution:

NPV A = $2,000(PVIF % , ) + $2,500(PVIF % , ) + $2,250(PVIF % , ) -

$5,000

= $2,000(0.8929) + $2,500(0.7972) + $2,250(0.7118) - $5,000

= $380.35 $380.

NPV B = $3,000(PVIF % , ) + $2,600(PVIF % ) + $2,900(PVIF % , )

- $5,000

= $3,000(0.8772) + $2,600(0.7695) + $2,900(0.6750) - $5,000

= $1,589.80 $1,590.

Financial calculator solution:

A : Inputs: CF = -5,000; CF = 2,000; CF = 2,500; CF = 2,250;

I = 12%

Output: NPV = $380.20 $380.

B : Inputs: CF = -5,000; CF = 3,000; CF = 2,600; CF = 2,900;

I = 14%

Output: NPV = $1,589.61 $1,590.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.