George & George is considering investing in a complete small business computer s

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

revenue = 32000 + 7000 = 39000

after tax cash flows

year 1 = 39000 -10000 - 9860 = 29140

year2 = 39000 - 16000 - 7820 = 31180

year3 = 39000 - 9600 - 9996 = 29004

year4 = 39000 - 5760 - 11301.60=27698.40

year 5 = 39000 - 5760 - 11301.60=27698.40

year 6 = 39000 - 2880 - 12280.80 = 26719.20

b) NPV = - 70,000 + 29,140 /(1+12%) + 31,180 /(1+12%)^2 + 29,004 /(1+12%)^3 + 27,698.4 /(1+12%)^4 + 27,698.4 /(1+12%)^5 + 26,719.2 /(1+12%)^6 = 48375.26477

0 = - 70,000 + 29,140 /(1+IRR%) + 31,180 /(1+IRR%)^2 + 29,004 /(1+IRR%)^3 + 27,698.4 /(1+IRR%)^4 + 27,698.4 /(1+1IRR%)^5 + 26,719.2 /(1+IRR%)^6

IRR = 34.57%

c)Yes, they should because the NPV of the computers is above 0, which means that they will win money with the buying.

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