Your firm is contemplating the purchase of a new $745,500 computer-based order e
ID: 2734664 • Letter: Y
Question
Your firm is contemplating the purchase of a new $745,500 computer-based order entry system. The system will be depreciated straight-line to zero over its seven-year life. It will be worth $45,000 at the end of that time. You will be able to reduce working capital by $40,000 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.
1. Suppose your required return on the project is 7 percent and your pretax cost savings are $195,000 per year. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
NPV?
2. Suppose your required return on the project is 7 percent and your pretax cost savings are $135,000 per year. What is the NPV of the project? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
NPV ?
Explanation / Answer
Present value of cash outflow =
Computer cost = $745500
Working capital = 40000
Total cash outflow = 785500
Present value factor = 1
Present value of cash outflow = 785500 * 1 = 785500
Depreciation each year = 745500/7 = 106500
Tax savings due to depreciation = 106500* 40% = 42600
Present value of cash Inflow =
Cash Inflow = (Pretax cost savings + Tax savings due to depreciation) * PVF + working capital at end of project life
= (195000 + 42600) * 5.3893 + 4000 * 0.6227
= 237600*5.3893 + 24908
= 1303837.68
NPV = Present value of cash Inflow - Present value of cash outflow
= 1203837.68 – 745500
= 558337.68
2. IF pretax cost savings are $135,000 per year
Present value of cash Inflow =
Cash Inflow = (Pretax cost savings + Tax savings due to depreciation) * PVF + working capital at end of project life
= (135000 + 42600) * 5.3893 + 4000 * 0.6227
= 177600*5.3893 + 24908
= 980479.68
NPV = Present value of cash Inflow - Present value of cash outflow
= 980479.68 – 745500
= 234979.68
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