Your firm is contemplating the purchase of a new $669,000 computer-based order e
ID: 2631354 • Letter: Y
Question
Your firm is contemplating the purchase of a new $669,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $55,000 at the end of that time. You will be able to reduce working capital by $50,000 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.
Suppose your required return on the project is 9 percent and your pretax cost savings are $205,000 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).)
Suppose your required return on the project is 9 percent and your pretax cost savings are $145,000 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).)
Your firm is contemplating the purchase of a new $669,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $55,000 at the end of that time. You will be able to reduce working capital by $50,000 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.
Explanation / Answer
Annual depreciation = 669,000 / 6 = 111,500
Initial investment = -669,000 + 50,000 = -619,000
Requirement 1
Annual cashflow = cost saving * (1-tax rate) + depreciation * tax rate = 205,000 * (1-35%) + 111,500 * 35% = 172,275
Last year cashflow = 172,275 - 50,000 + 55,000 * (1-35%) = 158,025
So NPV = -619,000 + 172,275 / (1+9%)^1 + 172,275 / (1+9%)^2 + 172,275 / (1+9%)^3 + 172,275 / (1+9%)^4 + 172,275 / (1+9%)^5 + 158,025 / (1+9%)^6 = 145,314.82
Answer: NPV = 145,314.82
Requirement 2
Annual cashflow = cost saving * (1-tax rate) + depreciation * tax rate = 145,000 * (1-35%) + 111,500 * 35% = 133,275
Last year cashflow = 133,275 - 50,000 + 55,000 * (1-35%) = 119,025
So NPV = -619,000 + 133,275 / (1+9%)^1 + 133,275 / (1+9%)^2 + 133,275 / (1+9%)^3 + 133,275 / (1+9%)^4 + 133,275 / (1+9%)^5 + 119,025 / (1+9%)^6 = -29,636.01
Answer: NPV = -29,636.01, i.e. negative 29,636.01
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