A law firm is considering investing in a complete small business. The intial inv

Question

A law firm is considering investing in a complete small business. The intial investment will be 35,000$. The small business is in the 5-year MACRS category, and the firm's tax rate is 34%. The small business is expected to provide additional revenue of 15,000$ per year for the next 6 years, and to reduce expenses by 10,000$ per year for the same period.

Depreciation per the 6 years: 7,000 / 11,200 / 6,720 / 4,025 / 4,025 / 2,030

Factors per the 6 years .893 / .797 / .712 / .636 / .567 / .507

1) Calculate the net after-tax cash flow from the investment.

2)Calculate the net present value of the system, given that the law firm's weighter average cost of capital is 12%.

3)Should they invest in the small business?

Explanation / Answer

Part A:

Part B:

NPV = -35000 + 18880/(1.12)^1 + 20308/(1.12)^2 + 18785/(1.12)^3 + 17871/(1.12)^4 + 17871/(1.12)^5 + 17185/(1.12)^6 = 41621.57 or 41622.

Part C

Yes, the computer system should be bought.

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Year 0 1 2 3 4 5 6 Initial Investment -$35,000 Increase in Revenue $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 Decline in Expenses $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 Depreciation $7,000 $11,200 $6,720 $4,032 $4,032 $2,016 EBIT $18,000 $13,800 $18,280 $20,968 $20,968 $22,984 Tax $6,120 $4,692 $6,215 $7,129 $7,129 $7,815 Profit After Tax $11,880 $9,108 $12,065 $13,839 $13,839 $15,169 Add: Depreciation $7,000 $11,200 $6,720 $4,032 $4,032 $2,016 Net cash flows -$35,000 $18,880 $20,308 $18,785 $17,871 $17,871 $17,185

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