Your firm is contemplating the purchase of a new $1,461,500 computer-based order

Question

Your firm is contemplating the purchase of a new $1,461,500 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $142,200 at the end of that time. You will be able to reduce working capital by $197,500 (this is a one-time reduction). The tax rate is 33 percent and your required return on the project is 20 percent and your pretax cost savings are $634,200 per year.

Requirement 1: What is the NPV of this project?

Requirement 2: What is the NPV if the pretax cost savings are $456,650 per year?

Requirement 3: At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?

Explanation / Answer

Reuirement 2)

Around pretax cost saving of $ $ 736,270 would be the value at which the company would be indifferent

Year 0 1 2 3 4 5 Cost of machine         (1,461,500) salvage value     142,000 reduction in working capital               197,500 Pretax cost saving     634,200     634,200     634,200     634,200     634,200 Depreciation (263,900) (263,900) (263,900) (263,900) (263,900) Profit     370,300     370,300     370,300     370,300     370,300 Tax @ 33%     122,199     122,199     122,199     122,199     122,199 after tax cashflow     248,101     248,101     248,101     248,101     248,101 tax benefit from depreciation        87,087        87,087        87,087        87,087        87,087 cash flow         (1,264,000)     335,188     335,188     335,188     335,188     477,188 PV at 20%         (1,264,000)     279,323     232,769     193,975     161,645     191,771 NPV             (204,516)

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