Your firm is contemplating the purchase of a new $642,000 computer-based order e
ID: 2643959 • Letter: Y
Question
Your firm is contemplating the purchase of a new $642,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $46,000 at the end of that time. You will be able to reduce working capital by $41,000 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 8 percent and your pretax cost savings are $196,000 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 8 percent and your pretax cost savings are $136,000 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 $642,000 computer-based order entry system. The system will be depreciated straight-line to zero over its six-year life. It will be worth $46,000 at the end of that time. You will be able to reduce working capital by $41,000 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
Working Notes:
1) Depreciation per year = (642000 - 0) / 6 = $107000
2) Working capital has been reduced by $41000 from the normal level at the beginning of period, due to the introduction of the new system. Hence $41000 has been taken as the positive cash flow at the beginning of the period (saving in cost)
3) Working capital has been reverted back to the normal level at the end of the period. Hence $41000 has been taken as the cash outflow at the end of the period.
4) After tax cash flow from the sale of machine:
Cash inflow from the sale of the machine = $ 46000
Less: Book value ot he system as on that date = 0
Profit on sale of machine $46000
Less: tax @ 35% $ 16100
After tax cash flow $29900
Requirement 1 Year 0 1 2 3 4 5 6 NPV Purchase of Equipment -6,42,000 Saving in Working Capital 41000 Pretax cost savings 196000 196000 196000 196000 196000 196000 Depreciation -107000 -107000 -107000 -107000 -107000 -107000 Pretax Cost savings after depreciation 89000 89000 89000 89000 89000 89000 Tax @ 35% -31150 -31150 -31150 -31150 -31150 -31150 After Tax Cost Savings 57850 57850 57850 57850 57850 57850 Depreciation 107000 107000 107000 107000 107000 107000 Total 164850 164850 164850 164850 164850 164850 After Tax Cash flow from the sale of machine 29900 Reverting back of Working Capital to normal -41000 Cash Flow After Tax -6,01,000 164850 164850 164850 164850 164850 153750 Discount Factor @ 8% 1 0.925926 0.857339 0.793832 0.73503 0.680583 0.63017 Discounted Cash Flow -601000 152638.9 141332.3 130863.2 121169.7 112194.1 96888.58 154086.83 Requirement 2 Year 0 1 2 3 4 5 6 NPV Purchase of Equipment -6,42,000 Saving in Working Capital 41000 Pretax cost savings 136000 136000 136000 136000 136000 136000 Depreciation -107000 -107000 -107000 -107000 -107000 -107000 Pretax Cost savings after depreciation 29000 29000 29000 29000 29000 29000 Tax @ 35% -10150 -10150 -10150 -10150 -10150 -10150 After Tax Cost Savings 18850 18850 18850 18850 18850 18850 Depreciation 107000 107000 107000 107000 107000 107000 Total 125850 125850 125850 125850 125850 125850 After Tax Cash flow from the sale of machine 29900 Reverting back of Working Capital to normal -41000 Cash Flow After Tax -6,01,000 125850 125850 125850 125850 125850 114750 Discount Factor @ 8% 1 0.925926 0.857339 0.793832 0.73503 0.680583 0.63017 Discounted Cash Flow -601000 116527.8 107896.1 99903.79 92503.51 85651.4 72311.96 -26205.48Related Questions
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