Your firm is contemplating the purchase of a new $444,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $444,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $43,200 at the end of that time. You will be able to reduce working capital by $60,000 (this is a one-time reduction). The tax rate is 33 percent and your required return on the project is 24 percent and your pretax cost savings are $153,700 per year. Requirement 1: What is the NPV of this project? Requirement 2: What is the NPV if the pretax cost savings are $213,500 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

Discount rate 24% Year 0 1 2 3 4 5 Initial investment -444000 Networking capital BENEFIT 60000 Depretiation(used for tax benefit) 88800 88800 88800 88800 88800 Pretax cost saving 153700 153700 153700 153700 153700 Salvage Value 43200 Net CF -384000 153700 153700 153700 153700 196900 Tax@33% 0 21417 21417 21417 21417 35673 Post tax CF -384000 132283 132283 132283 132283 161227 Discounted CF@24% -384000 106679.8 86032.13 69380.75 55952.22 54995.78 NPV -10959.3 Discount rate 24% Year 0 1 2 3 4 5 Initial investment -444000 Networking capital BENEFIT 60000 Depretiation(used for tax benefit) 88800 88800 88800 88800 88800 Pretax cost saving 213500 213500 213500 213500 213500 Salvage Value 43200 Net CF -384000 213500 213500 213500 213500 256700 Tax@33% 0 41151 41151 41151 41151 55407 Post tax CF -384000 172349 172349 172349 172349 201293 Discounted CF@24% -384000 138991.1 112089.6 90394.85 72899.08 68662.6 NPV 99037.28 Discount rate 24% Year 0 1 2 3 4 5 Initial investment -444000 Networking capital BENEFIT 60000 Depretiation(used for tax benefit) 88800 88800 88800 88800 88800 Pretax cost saving level of indefference 159658 159658 159658 159658 159658 Salvage Value 43200 Net CF -384000 159658 159658 159658 159658 202858 Tax@33% 0 23383.14 23383.14 23383.14 23383.14 37639.14 Post tax CF -384000 136274.9 136274.9 136274.9 136274.9 165218.9 Discounted CF@24% -384000 109899.1 88628.29 71474.43 57640.67 56357.43 NPV -0.10063 At around 159658 the company will be indifferent if to accept or reject the project

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