Your firm is contemplating the purchase of a new $666,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $666,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $64,800 at the end of that time. You will be able to reduce working capital by $90,000 (this is a one-time reduction). The tax rate is 32 percent and your required return on the project is 22 percent and your pretax cost savings are $302,300 per year. Requirement 1: What is the NPV of this project? Requirement 2: What is the NPV if the pretax cost savings are $217,650 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

Year' Cash flows PVF @ 10% PV 0 -666000 1 -666000 0 -90000 1 -90000 1 205564 0.820 168495.08 2 205564 0.672 138110.72 3 205564 0.551 113205.51 4 205564 0.451 92791.4 5 205564 0.370 76058.53 5 44064 0.370 16303.65 5 90000 0.370 33299.93 NPV -117735.18 Year' Cash flows PVF @ 10% PV 0 -666000 1 -666000 0 -90000 1 -90000 1 148002 0.820 121313.11 2 148002 0.672 99436.98 3 148002 0.551 81505.72 4 148002 0.451 66807.97 5 148002 0.370 54760.63 5 44064 0.370 16303.65 5 90000 0.370 33299.93 NPV -282572.01 Let pretax cost savings be X X(1-32%%)*PVAF(22%,5year) + Salvage Value*PVF(22%,5Yr) + WC Released*PVF(22%,5Yr) = 666000+90000 X(1-32%) * 2.864 + 44064 * 0.370 + 90000 * 0.370 = 756000 X(1-32%) * 2.864 + 16303.65 + 33299.93 = 756000 X(1-32%) * 2.864 = 756000-16303.65-33299.93 X(1-32%) * 2.864 = 706396.42 0.32X = 246646.79 X = 770771.22

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