Your firm is contemplating the purchase of a new $555,000 computer-based order e
ID: 2710452 • Letter: Y
Question
Your firm is contemplating the purchase of a new $555,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $55,000 at the end of that time. You will be able to reduce working capital by $70,000 (this is a one-time reduction). The tax rate is 35 percent and the required return on the project is 15 percent. If the pretax cost savings are $215,000 per year, what is the NPV of this project? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) NPV $ Will you accept or reject the project? Accept Reject If the pretax cost savings are $165,000 per year, what is the NPV of this project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) NPV $ Will you accept or reject the project? Reject Accept At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) Cost savings $
Explanation / Answer
1)
accept the project as NPV > 0
2)
reject project as NPV<0
3)
Therefore pretax savings = 170635.2 for NPV to be 0 causing the investor to be indifferent between accepting and rejecting the project
Time line 0 1 2 3 4 5 Cost of new machine -555000 Net working capital benefit 70000 =Initial Investment outlay -485000 Pretax cost saving 215000 215000 215000 215000 215000 -Depreciation Cost of new machine/5 -111000 -111000 -111000 -111000 -111000 =Pretax cash flows 104000 104000 104000 104000 104000 -taxes =(Pretax cash flows)*(1-tax) 67600 67600 67600 67600 67600 +Depreciation 111000 111000 111000 111000 111000 =after tax operating cash flow 178600 178600 178600 178600 178600 reversal of working capital benefit -70000 +Proceeds from sales after tax =selling price*(1 - tax rate) 35750 "=Terminal year after tax cash flows -34250 Total Cash flow for the period -485000 178600 178600 178600 178600 144350 Required rate of return= 15% Discount factor= (1+ required rate)^N 1 1.15 1.3225 1.520875 1.749006 2.011357 Discounted cash flow= total cash flow/discount factor -485000 155304.3 135047.3 117432.4 102115.1 71767.46 NPV= Sum of discounted cash flow = 96666.6Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.