The law firm of Dewey, Cheatum & Howe is considering investing in a complete sma

Question

The law firm of Dewey, Cheatum & Howe is considering investing in a complete small business computer system. The initial investment will be $50,000. The computer is in the 5-year MACRS category, and the firm's tax rate is 34%. The computer system is expected to provide additional revenue of $39,000 per year for the next six years.

a.Calculate the net after-tax cash flows from this investment..

b.Calculate the Net Present Value (NPV) and Internal Rate of Return (IRR) of the system, given that the law firm's weighted average cost of capital is 12%..

c.Should they buy the computer system? Why or why not?.

Explanation / Answer

Dewey, Cheatum and Howe All Amounts in $ a. After tax cash flows from the investment = 66% of $ 39,000 = 25740 $ b. Given that the weighted average cost of capital of the firm is 12% The Net Present Value of the system works out to $ 49,846.09 The IRR worked out on the Trial and Error basis method comes to 46.21% c. The Net Present Value of the system is positive, and also the IRR is above the average cost of capital. Hence, considering these factors, the firm should definitely buy the system.

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