The law firm of Bushmaster, Cobra and Asp is considering investing in a complete

Question

The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small business computer system.  The initial investment will be $35,000. The computer is in the

5-year MACRS category, and the firm's tax rate is 34%.  The computer system is expected to provide additional revenue of $15,000 per year for the next six years, and to reduce expenses by $10,000 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, that the law firm's weighted average cost of capital is 12%.

c)   Should they buy the computer system?

Please give as much information as possible so I can better understand. Thank you.

Explanation / Answer

Hi,

Please find the answer as follows;

Part A:

Part B:

NPV = -35000 + 18880/(1.12)^1 + 20308/(1.12)^2 + 18785/(1.12)^3 + 17871/(1.12)^4 + 17871/(1.12)^5 + 17185/(1.12)^6 = 41621.57 or 41622.

Part C

Yes, the computer system should be bought.

Thanks.

Year 0 1 2 3 4 5 6 Initial Investment -$35,000





Increase in Revenue
$15,000 $15,000 $15,000 $15,000 $15,000 $15,000 Decline in Expenses
$10,000 $10,000 $10,000 $10,000 $10,000 $10,000 Depreciation
$7,000 $11,200 $6,720 $4,032 $4,032 $2,016 EBIT
$18,000 $13,800 $18,280 $20,968 $20,968 $22,984 Tax
$6,120 $4,692 $6,215 $7,129 $7,129 $7,815 Profit After Tax
$11,880 $9,108 $12,065 $13,839 $13,839 $15,169 Add: Depreciation
$7,000 $11,200 $6,720 $4,032 $4,032 $2,016 Net cash flows -$35,000 $18,880 $20,308 $18,785 $17,871 $17,871 $17,185

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