Your firm is contemplating the purchase of a new $585,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $585,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $61,000 at the end of that time. You will be able to reduce working capital by $76,000 (this is a one-time reduction). The tax rate is 30 percent and the required return on the project is 16 percent.

If the pretax cost savings are $201,000 per year, what is the NPV of this project? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

NPV $

If the pretax cost savings are $151,000 per year, what is the NPV of this project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

NPV $

At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Cost savings $

Explanation / Answer

(1)

The NPV of this project is $50,766.26

(2)

The NPV of this project is - $63,834.02

(3)

-509,000 + (35100+0.7X)/1.16 + (35100+0.7X)/1.16^2 + (35100+0.7X)/1.16^3 + (35100+0.7X)/1.16^4 + (1800+0.7X)/1.16^5 = 0

X = 178,870.73

Therefore, the pretax cost savings is $178,870.73 per year.

? ? 0 1 2 3 4 5 initial investment a -585,000 ? ? ? ? ? depreciation tax shield c=-a/5*30% ? 35,100 35,100 35,100 35,100 35,100 aftertax costs save c ? 140,700 140,700 140,700 140,700 140,700 aftertax residual income d ? ? ? ? ? 42,700 working capital e 76,000 ? ? ? ? -76,000 OCF g=a+c+d+e -509,000 175,800 175,800 175,800 175,800 142,500 discount rate 16% ? ? ? ? ? ? NPV 50,766.26 -509,000 151551.7241 130648.038 112627.619 97092.77501 67846.1047

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