Preston Industries\' current sales volume is $100 million a year. Preston is exa

Question

Preston Industries' current sales volume is $100 million a year. Preston is examining the advantages of EDI (electronic data interchange). The technology will allow Preston to electronically communicate with suppliers and customers, send and receive purchase orders, invoices, and cash. It will save Preston Mmoney by lowering costs in the purchasing, customer service, accounts payable, and accounting departments. Initial estimates are that savings will equal $100,000 a year. Investment in EDI technology will include $500,000 in depreciable expenses and $100,000 in nondepreciable expenses. Assets will be depreciated on a straightline basis for four years. Implementation of EDI is expected to reduce Prestons net working capital $200,000. Because of changeing technology, Preston's president, Carol, wants to estimate the effect of switching to EDI on shareholder wealth over a four-year time horizon assuming that advances in technology will make the equipment worthless at the end of four years. At a 30 percent tax rate and 13 percent required rate of return, should Preston Industries switch to EDI?

Please show details. Thank you.

Explanation / Answer

Depreciation expenses =$500,000/4 =125000 Incremental cashflows =($100,000-125000)*(1-30%) + 125000 = $107,500 Initial investment =$500,000 + $100,000 -$200,000 = $400,000 NPV = -$400,000 +$107,500/1.13 +$107,500/1.13^2 +$107,500/1.13^3 +$107,500/1.13^4 NPV =-$80244.3325 NPV is negative which which means that project will have adverse effect on shareholder wealth. Preston should not Industries switch to EDI

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