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 and round your answer to 2 decimal places, e.g., 32.16.) NPV S 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? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPVS

Explanation / Answer

Answer: When pretax cost savings are $ 193,000 per year, NPV = $ 127,405.19

When pretax cost savings are $ 133,000 per year, NPV = - $ 47,544.91

Workings :

Initial Investment : Cost of the system - Cash inflow due to Working Capital reduction = - $ 633,000 + $ 38,000 = - $ 595,000

Annual depreciation = $ 633,000 / 6 = $ 105,500.

Annual operating cash flows after taxes (OCFAT) = Annual pretax cost savings x ( 1 - T ) + Annual Depreciation x T = $ 193,000 x 0.65 + $ 105,500 x 0.35 = $ 162,375

Terminal cash flows = Salvage value after tax - Working capital reverted = $ 43,000 x 0.65 - $ 38,000 = - $ 10,050

Net present value ( NPV) at 9% = Annual OCFAT x PVIFA 9%, 6 years + Terminal Cash Flows x PVIF 9%, 6years = $ 162,375 x 4.4859 - $ 10,050 x 0.5963 - $ 595,000 = $ 728,398.01 - $ 5,992.82 - $ 595,000 = $ 127,405.19

When pretax cost savings per year is $ 133,000, Annual OCFAT = $ 123,375

NPV at 9% = $ 123,375 x 4.4859 - $ 10,050 x 0.5963 - $ 595,000 = - $ 47,544.91

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