Your firm is contemplating the purchase of a new $633,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $633,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $43,000 at the end of that time. You will be able to reduce working capital by $38,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 35 percent.

Suppose your required return on the project is 9 percent and your pretax cost savings are $193,000 per year. What is the NPV of the project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Suppose your required return on the project is 9 percent and your pretax cost savings are $133,000 per year. What is the NPV of the project?

Your firm is contemplating the purchase of a new $633,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $43,000 at the end of that time. You will be able to reduce working capital by $38,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 35 percent.

Explanation / Answer

2.

Operating Cashflows Pretax Cost Savings (a) $193,000.00 Depreciation (b) $98,333.33 (633000-43000)/6 Post Tax Operating Cashflows (c = a*0.65) $125,450.00 Depreciation Tax Shield (d = b*0.35) $34,416.67 Annual Post tax operating cash flows (e = c+d) $159,866.67 Annuity Factor for 6 years at 9% (f) 4.4859 Present Value of Operating Cashflows (g=e*f) $717,148.85 Terminal Cashflows Working Capital (h) -$38,000.00 Salvage Value of Machine (i) $33,000.00 Total Terminal Cashflow (j=h+i) -$5,000.00 Present Value Factor for 6 years at 9% (k) 0.5963 Present Value of Terminal Cashflows (l=j*k) -$2,981.34 Initial Outflow Machine Cost (m) $633,000.00 Decrease in Working Capital (n) $38,000.00 Total Initial Outflow (o = m -n) $595,000.00 NPV = g+l-o $119,167.52 Since Salvage value is equal to purchase price + depreciation this amount equals post tax inflow from machinery

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