Question

Chema Corporation is considering the purchase of a new computer system which will be able to digitally process customer orders. Currently, Chema Corporation pays a number of employees a total of $50,000 per year to process orders and the new computer system will eliminate that expense. The new computer system costs $150,000 to purchase and install and has a 5 year life. The computer system will be sold at the end of the project for a net cash inflow of $10,800. Depreciation expenses will be $30,000 per year. If the tax rate is 28 percent and the WACC is 15 percent, should Chema Corporation purchase the new computer system? Use the NPV criteria to make your decision.

		The new computer system should be purchased because it will increase firm value by $4,205.
		The new computer system should be purchased because it will increase firm value by $6,569.
		The new computer system should be purchased because it will increase firm value by $9,441.
		The new computer system should be purchased because it will increase firm value by $10,359.
		The new computer system should be purchased because it will increase firm value by $304,205.

Answer 1

Answer:
The new computer system should be purchased because it will increase firm value by $4,205

Explanations:

NPV of old system:

After tax expense = $50,000 (salary expense) × (1-.28)

= $50,000 - $14,000 = $36,000

NPV = Annual cost (salary expense) × PVIFA 15%, 5

= -$36,000 × 3.3521551

= -$1,20,677.5

NPV of new system

Depreciation tax shield = $30,000 × 28% (tax rate)

= $8,400

NPV = Depreciation tax shield × PVIFA 15% , 5 + residual value × PVIF 15%, 5 - Initial cost

NPV = -$8400 × 3.3521551 + $10,800 × 0.497176 - $150,000

NPV = $28,158.1 + $5,369.5 - $150,000

NPV = -$1,16,472.4

increase in firms value = NPV of new system - NPV of old system

= -$1,16,472.4 - -$1,20,677.5

= $4,205