A firm is evaluating a cost-saving project that is expected to save the firm $22

Question

A firm is evaluating a cost-saving project that is expected to save the firm $225,000 before taxes each year. The company's tax rate is 30%. The project requires equipment that will cost $1.35 Million to install. The equipment has a 10-year lifetime and its value will be depreciated to zero over its life. It is expected that the equipment will be able to be sold for $50,000 in 10 years. The project also requires an initial net working capital investment of $5,000, which will be recouped at the end of the project. The required return for this project is 10%. Find the project's Net Present Value. Find the project Profitability Index. Find the payback period. Should they pursue the project?

Explanation / Answer

Statement showing Cash flows Particulars Time PVf@10% Amount PV Cash Outflows                       -                        1.00                   (1,350,000.00)                   (1,350,000.00) Cash Outflows (Invt in WC)                       -                        1.00                           (5,000.00)                           (5,000.00) PV of Cash outflows = PVCO                   (1,355,000.00) Cash inflows                   1.00                 0.9091                         198,000.00                         180,000.00 Cash inflows                   2.00                 0.8264                         198,000.00                         163,636.36 Cash inflows                   3.00                 0.7513                         198,000.00                         148,760.33 Cash inflows                   4.00                 0.6830                         198,000.00                         135,236.66 Cash inflows                   5.00                 0.6209                         198,000.00                         122,942.42 Cash inflows                   6.00                 0.5645                         198,000.00                         111,765.84 Cash inflows                   7.00                 0.5132                         198,000.00                         101,605.31 Cash inflows                   8.00                 0.4665                         198,000.00                           92,368.46 Cash inflows                   9.00                 0.4241                         198,000.00                           83,971.33 Cash inflows                10.00                 0.3855                         198,000.00                           76,337.57 Cash inflows (Salvage Value) = 50,000*.70                10.00                 0.3855                           35,000.00                           13,494.02 Cash inflows (Working Capital)                10.00                 0.3855                              5,000.00                              1,927.72 PV of Cash Inflows =PVCI                     1,232,046.02 NPV= PVCI - PVCO                       (122,953.98) Savings before Taxes      225,000.00 Depreciation = 1350,000/10      135,000.00 Incomebefore Tax        90,000.00 Tax @30%        27,000.00 Income after Tax        63,000.00 Add : Depreciation      135,000.00 Cash flow after tax      198,000.00

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