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