A materials manager proposed the purchase of a RFID Inventory System for the com
ID: 2652150 • Letter: A
Question
A materials manager proposed the purchase of a RFID Inventory System for the company’s warehouse. She claims that the proposed system would save time for warehouse personnel to locate and move inventory items. It also will progressively enable the reduction of inventory.
The annual savings from a reduction in warehouse people is expected to be $78,000 annually. Potential changes to wages payable should be ignored. The Inventory is presently valued at $1,500,000 and starting in year 2 and following it is expected to diminish by 10% annually (cumulatively).
The cost to purchase and install the system is estimated at $1,000,000 (in year 0) and will be depreciated using 5-year MACRS. The hardware portion of the system will be worth about $50,000 at the end of year 6. Use a 6-year analysis to determine if the proposal is justified. The pertinent data is listed below.
Determine the cash flows over the project life
Compute the IRR for this investment.
Cost and installation $1,000,000 Project life (years) 6 Estimated salvage value $50,000 in year 6 Warehouse personnel savings $75,000 annual Wages Payable reduction $3,000.00 Present Inventory $1,500,000 Annual cumulative decrease 10% starting in year 2 Depreciation MACRS years 5 Income & Capital Gains Tax 20% MARR 5% 0 1 2 3 4 5 6 Depreciation MACRS % 20% 32% 19.20% 11.52% 11.52% 5.76%Explanation / Answer
Answer:
Calculation of Cash flows and IRR
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
System Purchase and installation Costs
$ (1,000,000.00)
Add: Annual Saving (Net of tax) = 78000*(1-0.20)
$ 62,400.00
$ 62,400.00
$ 62,400.00
$ 62,400.00
$ 62,400.00
$ 62,400.00
Add : Reduction in inventory levels
$ 150,000.00
$ 135,000.00
$ 121,500.00
$ 109,350.00
$ 98,415.00
(1500000*10%)
(150000*90%)
(135000*90%)
(121500*90%)
(109350*90%)
Add: Tax Saving on Depreciation :
Depreciation %
20.00%
32.00%
19.20%
11.52%
11.52%
5.76%
Depreciation = 1000000 * %
$ 200,000.00
$ 320,000.00
$ 192,000.00
$ 115,200.00
$ 115,200.00
$ 57,600.00
Tax Saving = Depreciation * 20%
$ 40,000.00
$ 64,000.00
$ 38,400.00
$ 23,040.00
$ 23,040.00
$ 11,520.00
Salvage value (Net of tax) = 50000*(1-0.20)
$ 40,000.00
Net cash Flows
$ (1,000,000.00)
$ 102,400.00
$ 276,400.00
$ 235,800.00
$ 206,940.00
$ 194,790.00
$ 212,335.00
IRR =
5.99%
Calculation of Cash flows and IRR
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
System Purchase and installation Costs
$ (1,000,000.00)
Add: Annual Saving (Net of tax) = 78000*(1-0.20)
$ 62,400.00
$ 62,400.00
$ 62,400.00
$ 62,400.00
$ 62,400.00
$ 62,400.00
Add : Reduction in inventory levels
$ 150,000.00
$ 135,000.00
$ 121,500.00
$ 109,350.00
$ 98,415.00
(1500000*10%)
(150000*90%)
(135000*90%)
(121500*90%)
(109350*90%)
Add: Tax Saving on Depreciation :
Depreciation %
20.00%
32.00%
19.20%
11.52%
11.52%
5.76%
Depreciation = 1000000 * %
$ 200,000.00
$ 320,000.00
$ 192,000.00
$ 115,200.00
$ 115,200.00
$ 57,600.00
Tax Saving = Depreciation * 20%
$ 40,000.00
$ 64,000.00
$ 38,400.00
$ 23,040.00
$ 23,040.00
$ 11,520.00
Salvage value (Net of tax) = 50000*(1-0.20)
$ 40,000.00
Net cash Flows
$ (1,000,000.00)
$ 102,400.00
$ 276,400.00
$ 235,800.00
$ 206,940.00
$ 194,790.00
$ 212,335.00
IRR =
5.99%
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