The law firm of Bushmaster, Cobra and Asp is considering investing in a complete

Question

The law firm of Bushmaster, Cobra and Asp 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 $32,000 per year for the next six years, and to reduce expenses by $7,000 per year for the same period. a) Calculate the net after-tax cash flows from this investment. b) Calculate the net present value of the system, given that the law firm's weighted average cost of capital is 12%. c) Should they buy the computer system? Please show all work without table or excel.

Explanation / Answer

Yes, the firm should buy the computer system, as the NPV is positive.

Year 0 1 2 3 4 5 6 Income before depreciation 19,500 39,000 39,000 39,000 39,000 19,500 Depreciation 10,000 16,000 9,600 5,760 5,760 2,880 Income before tax 9,500 23,000 29,400 33,240 33,240 16,620 Income tax 3,230 7,820 9,996 11,302 11,302 5,651 Income after tax 6,270 15,180 19,404 21,938 21,938 10,969 After tax cash flows(Income after tax +depreciation) (50,000) 16,270 31,180 29,004 27,698 27,698 13,849 PV factor at 12% 1.000 0.893 0.797 0.712 0.636 0.567 0.507 Present values (50,000) 14,529.11 24,850.46 20,650.85 17,615,93 15,704.77 7,021.44 Net present value $ 50,372.56

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