You are evaluating the possible purchase of a new computer network for improved

Question

You are evaluating the possible purchase of a new computer network for improved inventory and order tracking. The system costs $80,000 and installation/site preparation costs $4,000. It has an expected life of 6 years and estimated salvage value of $1,000. This is classified as a 5- year MACRS class.

The company will borrow the full amount of initial investment (i.e. system costs and installation/site preparation costs). The bank loan interest rate is 11% APR compounded annually and the company will repay the loan in 5 equal annual payments.

Expected annual savings is $52,000 due to less inventory lost and better customer service from this improved tracking system.

There will be annual maintenance and upkeep expenses of $12,000. In addition, in year 1 there is an extra expense of $20,000 for some software customization.

The company’s tax rate is 21%. The company’s minimum attractive rate of return is 18%

a) Determine this project’s cash flows over the project life. • Use the project cash flow table

• Show supporting calculations in detail for the following:

1. Financing activities for all years -- also use the loan principal and interest table for summarizing answers for all years.

2. All depreciation values

3. All tax values (including any tax associated with salvage).

• Additionally, for Year 1, show all “simple” calculations of Taxable income, income tax, net income, and net cash flow. You do not need to show your work for these specific calculations in other years.

b) Based on present worth analysis of the net cash flows from this project, is your project acceptable and state why

Explanation / Answer

Also If you want the working notes please request it additionally

Modified Accelerated Cost Recovery System (MACRS) Depreciation - 5 Years class The 5-year class will be determined based upon the table given below The total cost of machinery System cost $84,000 Installation 4000 Total 88000 Year Factor Depreciation Book Value 1 20% 17600 70400 2 32% 28160 42240 3 19.20% 16896 25344 4 11.52% 10137.6 15206.4 5 11.52% 10137.6 5068.8 6 5.76% 5068.8 0 Note: Software customization is taken as an extra cost not included in the machinery Now let us work out the amortization schedule Loan amount $84,000 Annual periodic Interest rate 11% Loan repayment is in Five equal annual payments Instalment amount Year Opening Amt Payment Principal Interest Balance 1 $84,000 ($22,727.91) ($13,487.91) ($9,240.00) $70,512.09 2 $70,512.09 ($22,727.91) ($14,971.58) ($7,756.33) $55,540.52 3 $55,540.52 ($22,727.91) ($16,618.45) ($6,109.46) $38,922.07 4 $38,922.07 ($22,727.91) ($18,446.48) ($4,281.43) $20,475.59 5 $20,475.59 ($22,727.91) ($20,475.59) ($2,252.32) $0.00 Now let us look at the company statement for the 5 years period COST REDUCTION Year Realized Savings Tax to be paid Savings Net of Tax 1 52000 10920 41080 2 52000 10920 41080 3 52000 10920 41080 4 52000 10920 41080 5 52000 10920 41080 Depreciation tax benefit Depreciation Tax benefit 1 17600 3696 2 28160 5914 3 16896 3548 4 10137.6 2129 5 10137.6 2129 5068.8 1064 all tax values Year Total tax paid would be 1 37384 2 35166 3 37532 4 38951 5 38951 Annual maintenance expense 12000 Extra expense in year 1 20000 Project Cash flow table Y0 Yr1 Yr2 Yr3 Yr4 Yr5 Initial cost 84000 0 0 0 0 0 annual maintenance expenses 0 12000 12000 12000 12000 12000 Extra expense in year 1 0 20000 0 0 0 0 Tax benefit from depreciation 0 3696 5913.6 3548.16 2128.896 2128.896 1064.448 Cost reduction 0 41080 41080 41080 41080 41080 Total 84000 76776 58994 56628 55209 55209 PV of the cash flow ($84,000.00) $65,064.41 $42,368.28 $34,465.65 $28,476.13 $24,132.32 Net present value $110,506.79 Based upon the above analysis it makes sense to invest in the project This part is not solved - Please try it on your own • Additionally, for Year 1, show all “simple” calculations of Taxable income, income tax, net income, and net cash flow. You do not need to show your work for these specific calculations in other years.

Also If you want the working notes please request it additionally

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