Question

Your firm is contemplating the purchase of a new $480,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $30,000 at the end of that time. You will be able to reduce working capital by $35,000 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. Requirement 1: Suppose your required return on the project is 10 percent and your pretax cost savings are $155,000 per year. What is the NPV of the project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) NPV $ Requirement 2: Suppose your required return on the project is 10 percent and your pretax cost savings are $125,000 per year. What is the NPV of the project? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).)

Answer #1

Annual cashflows | ||||

Annual savings | 155000 | |||

Less: Tax @ 35% | -54250 | |||

Tax shield on dep | 33600 | |||

(480000/5* 35%) | ||||

Annual cash inflows | 134350 | |||

Annuity PVF at 10% for 5 yrs | 3.79079 | |||

Present value of Annual inflows | 509292.6 | |||

Working capital release in beginning | 35000 | |||

After tax present value of salvage | 12107.96 | |||

(30000-35%) *0.620921 | ||||

Total Inflows | 556400 | |||

Less: Present value of outflows | ||||

Initial Investment | -480000 | |||

Present value of WC investment | -21732.2 | |||

(35000*0.620921) | ||||

Net Present value | 54668 | |||

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