Scott Investors, Inc., is considering the purchase of a $360,000 computer with a

Question

Scott Investors, Inc., is considering the purchase of a $360,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method. The market value of the computer will be $60,000 in five years. The computer will replace five office employees whose combined annual salaries are $105,000. The machine will also immediately lower the firm’s required net working capital by $80,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 34 percent. The appropriate discount rate is 12 percent.

Calculate the NPV of this project

Explanation / Answer

Cost of Computer= $360000

Economic Life=5 years

Depreciation Method-SLM

Market value at End= $60000

Saving in Employees Salaries=$105000

Decrease in Working Capital=$80000

Corporate Tax Rate=34%

Discount Rate=12%

Calculation of Npv

Initial Outflow=$360000-$80000=$280000

Cash Inflows/Savings:-

Saving of employees salaries=105000*PVAF,12%,5YEARS=$378525

Tax Saving through depreciation=(360000-60000)/5=60000*34%=20400*PVAF,12%,5YEARS=$73542

Present Value of Market Value to be fetched at end of the life of Computer=60000*PVIF,12%,5TH YEAR=$34020

Total Inflows=$378525+$73542+$34020=$486087

Less:Replacement of Working Capital=$45360

($80000*PVIF,12%,5TH YEAR)

Present Value of Cash Inflow/Savings=$486087-$45360=$440727

Net Present Value of the project=Present Value of Cash Inflow-Initial Outflow=$440727-$280000=$160727

($80000*PVIF,12%,5TH YEAR)

Hence, as the NPV of the project is positive so we can accept the project.

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