Your firm is contemplating the purchase of a new $550,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $550,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $54,000 at the end of that time. You will be able to reduce working capital by $69,000 (this is a one-time reduction). The tax rate is 30 percent and the required return on the project is 16 percent. If the pretax cost savings are $216,000 per year, what is the NPV of this project? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) NPV $ 107270.1 Will you accept or reject the project? Reject Accept If the pretax cost savings are $166,000 per year, what is the NPV of this project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places, e.g, 32.16.) NPV $-7330.12 Will you accept or reject the project? Reject Accept At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Cost savings

Explanation / Answer

Answer:

Cost 550000 Less: Reduction in Working Capital 69000 Net Cash Outflow at the begning 481000 Less: Present value of Salvage 17997 (54000*.7)/1.16^5 Net cash outflow 463003 Now Let Annual Saving is X Less: Depreciation =550000/5 110000 Net Saving X-110000 Net Saving after Tax 0.7X-77000 Add: Depreciation 110000 Annual Cash Flow 0.7X+33000 Rate of Return 16% Annuaity 3.2743 Total Cashflow 2.292X+108052 Indifference Point = Outflow = Inflow Therefore = 463003 = 2.292X+108052 So 2.292X = 354951 Therefore X = 154865 So if annual Savin will Be $154865 Then it should be indifference

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