Your firm is contemplating the purchase of a new $625,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $625,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $69,000 at the end of that time. You will be able to reduce working capital by $84,000 (this is a one-time reduction). The tax rate is 35 percent and the required return on the project is 15 percent.

If the pretax cost savings are $209,000 per year, what is the NPV of this project? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)

If the pretax cost savings are $159,000 per year, what is the NPV of this project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)

At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)

Your firm is contemplating the purchase of a new $625,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $69,000 at the end of that time. You will be able to reduce working capital by $84,000 (this is a one-time reduction). The tax rate is 35 percent and the required return on the project is 15 percent.

Explanation / Answer

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To be indifferent between accepting and not accepting the project the pretax cost saving should be 189915.8

Time line 0 1 2 3 4 5 Cost of new machine -625000 Net working capital benefit 84000 =Initial Investment outlay -541000 Pretax cost saving 209000 209000 209000 209000 209000 -Depreciation Cost of new machine/5 -125000 -125000 -125000 -125000 -125000 =Pretax cash flows 84000 84000 84000 84000 84000 -taxes =(Pretax cash flows)*(1-tax) 54600 54600 54600 54600 54600 +Depreciation 125000 125000 125000 125000 125000 =after tax operating cash flow 179600 179600 179600 179600 179600 reversal of working capital benefit -84000 +Proceeds from sales after tax =selling price*(1 - tax rate) 44850 "=Terminal year after tax cash flows -39150 Total Cash flow for the period -541000 179600 179600 179600 179600 140450 Required rate of return= 15% Discount factor= (1+ required rate)^N 1 1.15 1.3225 1.520875 1.749006 2.011357 Discounted cash flow= total cash flow/discount factor -541000 156173.9 135803.4 118089.9 102686.9 69828.47 NPV= Sum of discounted cash flow = 41582.59

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