Scenario 13-1 The information below applies to the following problem(s). The pre

Question

Scenario 13-1The information below applies to the following problem(s).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 into the MACRS 3-year class. Purchase of the computer would require an increase in net operating working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be 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 Scenario 13-1. What is the project's NPV?

$2,622

$2,803

$2,917

$5,712

$6,438

The Unlimited, a national retailing chain, is considering an investment in one of two mutually exclusive projects. The discount rate used for Project A is 12 percent. Further, Project A costs $15,000, and it would be depreciated using MACRS. It is expected to have an after-tax salvage value of $5,000 at the end of 6 years and to produce after-tax cash flows (including depreciation) of $4,000 for each of the 6 years. Project B costs $14,815 and would also be depreciated using MACRS. B is expected to have a zero salvage value at the end of its 6-year life and to produce after-tax cash flows (including depreciation) of $5,100 each year for 6 years. The Unlimited's marginal tax rate is 40 percent. What risk-adjusted discount rate will equate the NPV of Project B to that of Project A? [Hint: Ask me in class!]

15%

16%

18%

20%

12%

$2,622

$2,803

$2,917

$5,712

$6,438

Explanation / Answer

SOLUTION:

1. Calculation of NPV of Real Time Inc.

Computer Price = $40,000 + $2,000 (Increase in net working capital) = $42,000    

Using MACRS 3-Year Class,

Year 0 = -$42,000

Year 1 = $14,280

Year 2 = $16,200

Year 3 = $11,400       

PV = $18,120

Cash flow = $29,520

NPV at 14%,

NPV = -$42,000 + $14,280 (1 / 1.14) + $16,200 (1 / 1.14)2 + $11,400 (1 / 1.14)3

NPV = -$42,000 + $14,280 (0.8772) + $16,200 (0.7695) + $11,400 (0.6750)

NPV = $2918.32

Note: Numerical answer will differ from the answer that is calculated through financial calculator due to the factor of rounding.

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