Your firm is contemplating the purchase of a new $605,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $605,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $65,000 at the end of that time. You will be able to reduce working capital by $80,000 (this is a one-time reduction). The tax rate is 34 percent and the required return on the project is 14 percent.

If the pretax cost savings are $205,000 per year, what is the NPV of this project?

If the pretax cost savings are $155,000 per year, what is the NPV of this project?

At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it (cost-savings in terms of $)

If the pretax cost savings are $155,000 per year, what is the NPV of this project?

At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it (cost-savings in terms of $)

Explanation / Answer

(a)

Therefore, the NPV of this project is $61,464.23 if the pretax cost savings are $205,000 per year.

(b)

Therefore, the NPV of this project is - $51,827.44 if the pretax cost savings are $155,000 per year.

(c)

0 = -525,000 + (41140+0.66X)/1.14 + (41140+0.66X)/1.14^2 + (41140+0.66X)/1.14^3 + (41140+0.66X)/1.14^4 + (4040+0.66X)/1.14^5

X = 177,873.46

If the pretax cost savings is $177,873.46 you would be indifferent between accepting the project and not accepting it.

0 1 2 3 4 5 initial investment a -605,000 depreciation tax shield b=-a/5*34% 41,140 41,140 41,140 41,140 41,140 aftertax salvage value c=65,000*66% 42,900 aftertax costs saving d=205,000*66% 135,300.00 135,300.00 135,300.00 135,300.00 135,300.00 working capital e 80,000 -80,000 OCF f=a+b+c+d+e -525,000 176,440 176,440 176,440 176,440 139,340 discount rate 14% NPV 61,464.23 -525,000 154771.9298 135764.8507 119091.9743 104466.6441 72368.82969

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