George & George is considering investing in a complete small business computer s
ID: 2701641 • Letter: G
Question
George & George is considering investing in a complete small business computer system. The initial investment will be $70,000. The computer is in the 5-year MACRS category, and the firm's tax rate is 43%. The computer system is expected to provide additional revenue of $32,000 per year for the next six years, and to reduce expenses by $7,000 per year for the same period.
a) Calculate the net after-tax cash flows from this investment.
b) Calculate the net present value of the system, given that the law firm's weighted average cost of capital is 12%. Compute IRR in Excel using IRR formula.
c) Should they buy the computer system?
Explanation / Answer
a. Year 0 cashflow = -70,000
Year 1 depreciation = 20%*70,000 = 14,000
Year 2 depreciation = 32%*70,000 = 22,400
Year 3 depreciation = 19.2% = 13,440
Year 4 depreciation = 11.52% = 8,064
Year 5 depreciation = 11.52% = 8,064
Year 6 depreciation = 5.76% = 4,032
Post-tax cashflows:
Year 1 cashflow = (32,000+7,000-14,000)*(1-43%)+14,000 = 28,250
Year 2 cashflow = (32,000+7,000-22,400)*(1-43%)+22,400 = 31,862
Year 3 cashflow = (32,000+7,000-13,440)*(1-43%)+13,440 = 28,009
Year 4 cashflow = (32,000+7,000-8,064)*(1-43%)+8,064 = 25,698
Year 5 cashflow = (32,000+7,000-8,064)*(1-43%)+8,064 = 25,698
Year 6 cashflow = (32,000+7,000-4,032)*(1-43%)+4,032 = 23,964
b. NPV = -70,000 + 28,250/(1+12%)^1 + 31,862/(1+12%)^2 + 28,009/(1+12%)^3 + 25,698/(1+12%)^4 + 25,698/(1+12%)^5 + 23,964/(1+12%)^6 = $43,613
Pls insert values -70000, 28250, 31862, 28009, 25698, 25698, 23964 in cells A1, B1, C1, D1, E1, F1, G1. Then in any other cell, use the formula =IRR(A1:G1). This will be equal to 18.67%
c. As the NPV is greater than zero, and the IRR (18.67%) is also greater than their cost of capital (12%), they should buy the computer system.
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