Please show all work, thanks Your firm is contemplating the purchase of a new $7

Question

Please show all work, thanks

Your firm is contemplating the purchase of a new $763,000 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $50,000 at the end of that time. You will be able to reduce working capital by $45,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 30 percent. Requirement 1: Suppose your required return on the project is 8 percent and your pretax cost savings are $200,000 per year. What is the NPV of the project? Requirement 2: Suppose your required return on the project is 8 percent and your pretax cost savings are $140,000 per year. What is the NPV of the project?

Explanation / Answer

PV = Cashflow/(1+i)^n

i = rate of interest and n is the number of period.

Year 0 1 2 3 4 5 6 7 Purchase         (763,000) Salvage value        50,000 Depreciation (101,857) (101,857) (101,857) (101,857) (101,857) (101,857) (101,857) Working capital saving              45,000 Savings on Depreciation        30,557        30,557        30,557        30,557        30,557        30,557        30,557 Saving from project     200,000     200,000     200,000     200,000     200,000     200,000     200,000 Total cashoutflow/inflow         (718,000)     128,700     128,700     128,700     128,700     128,700     128,700     178,700 PV of cash flows         (718,000)     119,167     110,340     102,166        94,598        87,591        81,103     104,270 NPV           (18,766) Second case Year 0 1 2 3 4 5 6 7 Purchase         (763,000) Salvage value        50,000 Depreciation (101,857) (101,857) (101,857) (101,857) (101,857) (101,857) (101,857) Working capital saving              45,000 Savings on Depreciation        30,557        30,557        30,557        30,557        30,557        30,557        30,557 Saving from project     140,000     140,000     140,000     140,000     140,000     140,000     140,000 Total cashoutflow/inflow         (718,000)        68,700        68,700        68,700        68,700        68,700        68,700     118,700 PV of cash flows         (718,000)        63,611        58,899        54,536        50,497        46,756        43,293        69,260 NPV         (331,148)

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