Your firm is contemplating the purchase of a new $787,500 computer-based order e
ID: 2712737 • Letter: Y
Question
Your firm is contemplating the purchase of a new $787,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $57,000 at the end of that time. You will be able to reduce working capital by $52,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 40 percent.
Suppose your required return on the project is 7 percent and your pretax cost savings are $207,000 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).)
Suppose your required return on the project is 7 percent and your pretax cost savings are $147,000 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).)
Your firm is contemplating the purchase of a new $787,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $57,000 at the end of that time. You will be able to reduce working capital by $52,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 40 percent.
Explanation / Answer
Requirement 1:- Computation of NPV when pretax cost savings are $207,000 per year Year Cash Flow ($) Remarks for fund Depreciation Taxable profit Tax at 40% Cash flow after tax Discounting factor at 7% Discounted Cash Flow ($) a b c d (= b-c) e (= d x 40%) f(= c+d-e) h I (= fxh) 0 (787,500.00) Initial outlay (787,500.00) 1 (787,500.00) 0 52,000.00 WC saving 52,000.00 1 52,000.00 1 207,000.00 Cost saving 104357.14 102,642.86 41,057.14 165,942.86 0.935 155,156.57 2 207,000.00 Cost saving 104357.14 102,642.86 41,057.14 165,942.86 0.873 144,868.11 3 207,000.00 Cost saving 104357.14 102,642.86 41,057.14 165,942.86 0.816 135,409.37 4 207,000.00 Cost saving 104357.14 102,642.86 41,057.14 165,942.86 0.763 126,614.40 5 207,000.00 Cost saving 104357.14 102,642.86 41,057.14 165,942.86 0.713 118,317.26 6 207,000.00 Cost saving 104357.14 102,642.86 41,057.14 165,942.86 0.666 110,517.94 7 207,000.00 Cost saving 104357.14 102,642.86 41,057.14 165,942.86 0.623 103,382.40 7 (52,000.00) WC reinduce - (52,000.00) 0.623 (52,000.00) 7 57,000.00 Salvage value 57000 22,800.00 34,200.00 0.623 21,306.60 NPV 128,072.66 Requirement 2:- Computation of NPV when pretax cost savings are $147,000 per year Year Cash Flow ($) Remarks for fund Depreciation Taxable profit Tax at 40% Cash flow after tax Discounting factor at 7% Discounted Cash Flow ($) a b c d (= b-c) e (= d x 40%) f(= c+d-e) h I (= fxh) 0 (787,500.00) Initial outlay (787,500.00) 1 (787,500.00) 0 52,000.00 WC saving 52,000.00 1 52,000.00 1 147,000.00 Cost saving 104357.14 42,642.86 17,057.14 129,942.86 0.935 121,496.57 2 147,000.00 Cost saving 104357.14 42,642.86 17,057.14 129,942.86 0.873 113,440.11 3 147,000.00 Cost saving 104357.14 42,642.86 17,057.14 129,942.86 0.816 106,033.37 4 147,000.00 Cost saving 104357.14 42,642.86 17,057.14 129,942.86 0.763 99,146.40 5 147,000.00 Cost saving 104357.14 42,642.86 17,057.14 129,942.86 0.713 92,649.26 6 147,000.00 Cost saving 104357.14 42,642.86 17,057.14 129,942.86 0.666 86,541.94 7 147,000.00 Cost saving 104357.14 42,642.86 17,057.14 129,942.86 0.623 80,954.40 7 (52,000.00) WC reinduce - (52,000.00) 0.623 (32,396.00) 7 57,000.00 Salvage value 57000 22,800.00 34,200.00 0.623 21,306.60 NPV (46,327.34) Note: 1) Depreciation per year : Initial Cost 787500 Less Salvage value 57000 730500 Divided by & years 7 Annual depreciation 104357.14 2) WC = working capital
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