MRE Sales is looking to acquire an ERP and has asked for your assistance. The co

Question

MRE Sales is looking to acquire an ERP and has asked for your assistance. The company can purchase the system outright for $120,000 plus 5% sales tax, and delivery and install charges of $2,000. The ERP is expected to last 5 years and have a salvage value of $8,000. The company will use straight-line depreciation over the 5-year life. Its income tax rate is 40%. The company’s cost of capital is 12%. The system is expected to bring annual benefits of $35,000 over the 5-year period. Showing all calculations in Excel: a. Compute the NPV of the project b. Compute its payback period

Explanation / Answer

Ans;

a. Compute the NPV of the project Total Cash Outflow Purchase price of ERP 120,000 Add Sales Tax @ 5% 6000 Add Installation charges 2000 Total Cash Outflow 128,000 Calculation of Cash Flow after Tax Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Annual Benefits 35,000 35,000 35,000 35,000 35,000 Less Tax @ 40% 14000 14000 14000 14000 14000 Earnings after tax 21,000 21,000 21,000 21,000 21,000 Add Depreciation 24000 24000 24000 24000 24000 Add Salvage Value 8000 Cash Flow after Taxes 45,000 45,000 45,000 45,000 53,000 Calculation of NPV Year Amount $ P.V @12% Total P.V 0 -128,000 1 -128000 1 45,000 0.893 40185 2 45,000 0.797 35865 3 45,000 0.712 32040 4 45,000 0.636 28620 5 53,000 0.567 30051 Total NPV 38761 b. Compute its payback period Year Cash Inflows Cummulative Cash Inflow 1 45,000 45,000 2 45,000 90,000 3 45,000 135,000 4 45,000 180,000 5 53,000 233,000 Pay Back Period = 2nd Year + Total cash outflow - Cummulative cash inflow in 2nd Year cash Inflow in 3rd Year 2nd year+                  $128,000 - $90,000 $45,000 2nd Year                        + 0.84 2.84 Years

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