Your firm is contemplating the purchase of a new $565,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $565,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $57,000 at the end of that time. You will be able to reduce working capital by $72,000 (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 $213,000 per year, what is the NPV of this project?Will you accept or reject the project? If the pretax cost savings are $163,000 per year, what is the NPV of this project? Will you accept or reject the project? At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?

Explanation / Answer

(1)

The NPV of this project is $90,912.51

(2)

The NPV of this project is - $23,687.77 if the pretax cost savings are $163,000 per year, the project is NOT acceptable.

? ? 0 1 2 3 4 5 initial investment a -565,000 depreciation tax shield b=-a/5*30% 33,900 33,900 33,900 33,900 33,900 aftertax salvage value c=57,000*70% ? 39,900 aftertax costs saving d=213,000*70% 149,100.00 149,100.00 149,100.00 149,100.00 149,100.00 working capital e 72,000 -72,000 OCF f=a+b+c+d+e -493,000 183,000 183,000 183,000 183,000 150,900 discount rate 16% NPV 90,912.51 -493,000 157758.6207 135998.81 117240.35 101069.27 71845.454

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