Question

Hicks is considering the purchase of a new computer system for $80,000, plus the 6 percent Ohio State sales tax. The system will require an additional $10,000 for installation. If the new computer is purchased it will replace an old system that has been fully depreciated. The computer system, which has a useful life of 10-years, is expected to increase revenues by $32,000 per year over its useful life. Operating costs are expected to decrease by $2,000 per year over the life of the system. Hicks has a 10 percent cost of capital.

1. What is the net investment?
2. Compute the annual net cash flows.
3. What is the project’s internal rate of return? What is the project’s payback time?
4. Should Hicks make the purchase?

Answer 1

(a) Calculation of net investment:-

Particulars	Amount($)
Purchase Price of new computer system	80,000
Add- State Sales Tax (6%) (80000*6/100)	4,800
Add- Installation Cast	10,000
Net Investment cost	$94,800

(b) Computation of Annual Net Cash FLow:-

Year	Reveue($)	Cost($)	Net cash Flow($)
1-10	32000	-2000	30000

(c) Calculation of project IRR:-

NPV= P.V of Cash Inflow - P.V. of Cashoutflow

0= 30,000 * PVAF - 94800

Now, we will calculate IRR

Year	Cash Flow	PVAF@25%	NPV	PVAF30@	NPV
0	-94800	1	-94800	1	-94800
1-10	30000	3.5705	107115	3.0915	92745
	NPV		12315		-2055

IRR= Lower Rate+ Lowerr rate NPV / Lower rate NPV- Higher Rate NPV * higher rate -lower rate

= 25+ 12315 / 12315-(-2055) * (30-25)

IRR = 29.28%

Project Payback time:-

= Total Invertment / Net cash flow

= $94,800 / $30000

= 3.16

(d) In the given cash Hicks can purchase new computer.