The president of Real Time Inc. has asked you to evaluate the proposed acquisiti

Question

The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $40,000, and it falls in the MACRS 3-year class. The applicable depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. Purchase of the computer would require an increase in accounts payable of $2,000. The computer would have an EBT & Depreciation of $15,000. The computer is expected to be used for three years and then sold for $25,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent.

Refer to Real Time Inc. What is the project's NPV?

Explanation / Answer

Risk-adjusted NPV

Time lines:

Project A

0 1 2 3 Periods

k = 12%

CFs A -5,000 2,000 2,500 2,250

NPV A = ?

Project B

0 1 2 3 Periods

k = 14%

CFs B -5,000 3,000 2,600 2,900

NPV B = ?

Project A: k Average risk = 12%.

Project B: k High risk = 12% + 2% = 14%.

Tabular solution:

NPV A = $2,000(PVIF % , ) + $2,500(PVIF % , ) + $2,250(PVIF % , ) -

$5,000

= $2,000(0.8929) + $2,500(0.7972) + $2,250(0.7118) - $5,000

= $380.35 $380.

NPV B = $3,000(PVIF % , ) + $2,600(PVIF % ) + $2,900(PVIF % , )

- $5,000

= $3,000(0.8772) + $2,600(0.7695) + $2,900(0.6750) - $5,000

= $1,589.80 $1,590.

Financial calculator solution:

A : Inputs: CF = -5,000; CF = 2,000; CF = 2,500; CF = 2,250;

I = 12%

Output: NPV = $380.20 $380.

B : Inputs: CF = -5,000; CF = 3,000; CF = 2,600; CF = 2,900;

I = 14%

Output: NPV = $1,589.61 $1,590.

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