Your firm is contemplating the purchase of a new $759,500 computer-based order e
ID: 2712152 • Letter: Y
Question
Your firm is contemplating the purchase of a new $759,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $49,000 at the end of that time. You will be able to reduce working capital by $44,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 35 percent.
Requirement 1: Suppose your required return on the project is 7 percent and your pretax cost savings are $199,000 per year. What is the NPV of the project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) NPV $
Requirement 2: Suppose your required return on the project is 7 percent and your pretax cost savings are $139,000 per year. What is the NPV of the project? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).) NPV $
Explanation / Answer
a)Annual depreciation = (cost of asset – Salvage value)/ life
= (759,500 -0)/7
=108500
Depreciation tax shield = depreciation x tax rate
=108500 x 35%
=37,975
Net salvage value = salvage value x (1- tax rate)
= 49,000 x(1-0.35)
= 31,850
Operating cash flow
Year
cost savings
Tax 35%
Net Income
Depreciation tax shield
OCF
1
199000
69650
129350
37975
167325
2
199000
69650
129350
37975
167325
3
199000
69650
129350
37975
167325
4
199000
69650
129350
37975
167325
5
199000
69650
129350
37975
167325
6
199000
69650
129350
37975
167325
7
199000
69650
129350
37975
167325
Calculation of NPV
Year
Initial investment
Working capital
Net Salvage value
OCF
Total cash flow
PV factor 7%
PV
0
-759500
44000.0000
-715500.00
1.0000
-715500
1
167325.00
167325.00
0.9346
156378.505
2
167325.00
167325.00
0.8734
146148.135
3
167325.00
167325.00
0.8163
136587.042
4
167325.00
167325.00
0.7629
127651.441
5
167325.00
167325.00
0.7130
119300.412
6
167325.00
167325.00
0.6663
111495.713
7
-44000.0000
31850.0000
167325.00
155175.00
0.6227
96635.1912
NPV
178696.44
Hence, NPV would be 178696.44.
b) Operating cash flow
Year
cost savings
Tax 35%
Net Income
Depreciation tax shield
OCF
1
139000
48650
90350
37975
128325
2
139000
48650
90350
37975
128325
3
139000
48650
90350
37975
128325
4
139000
48650
90350
37975
128325
5
139000
48650
90350
37975
128325
6
139000
48650
90350
37975
128325
7
139000
48650
90350
37975
128325
Year
Initial investment
Working capital
Net Salvage value
OCF
Total cash flow
PV factor 7%
PV
0
-759500
44000.0000
-715500.00
1.0000
-715500
1
128325.00
128325.00
0.9346
119929.907
2
128325.00
128325.00
0.8734
112084.025
3
128325.00
128325.00
0.8163
104751.425
4
128325.00
128325.00
0.7629
97898.5281
5
128325.00
128325.00
0.7130
91493.9515
6
128325.00
128325.00
0.6663
85508.3659
7
-44000.0000
31850.0000
128325.00
116175.00
0.6227
72347.9513
NPV
-31485.85
Hence NPV would be -31485.85.
Year
cost savings
Tax 35%
Net Income
Depreciation tax shield
OCF
1
199000
69650
129350
37975
167325
2
199000
69650
129350
37975
167325
3
199000
69650
129350
37975
167325
4
199000
69650
129350
37975
167325
5
199000
69650
129350
37975
167325
6
199000
69650
129350
37975
167325
7
199000
69650
129350
37975
167325
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