Your firm is contemplating the purchase of a new $481,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $481,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $46,800 at the end of that time. You will be able to reduce working capital by $65,000 (this is a one-time reduction). The tax rate is 32 percent and your required return on the project is 18 percent and your pretax cost savings are $141,450 per year.

At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?

Your firm is contemplating the purchase of a new $481,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $46,800 at the end of that time. You will be able to reduce working capital by $65,000 (this is a one-time reduction). The tax rate is 32 percent and your required return on the project is 18 percent and your pretax cost savings are $141,450 per year.

Explanation / Answer

Ans1 Calculation of NPV 0 1 2 3 4 5 Initial investment -481000 Cost saving 141450 141450 141450 141450 141450 Less: Tax @32% 45264 45264 45264 45264 45264 Net saving 96186 96186 96186 96186 96186 Add tax save on dep 27789 27789 27789 27789 27789 Add: Selvage value 46800 less: Tax paid on selvage -14976 Add: reduction in working capital 65000 Net cash flow -481000 310689 310689 310689 310689 407513 Calculation of depreciation (481000-46800)/5 86840 Tax save on depreciation 86840*32% 27789 Tax paid on selvage value 46800*32%= 14976 Calculation of NPV year Cash flow PVAF 18% Net cash flow 0 -481000 1 -481000 1 310689 0.8475 263295.8 2 310689 0.7182 223132 3 310689 0.6086 189094.9 4 310689 0.5158 160249.9 5 407513 0.4371 178127.7 NPV 532900.3 Case 2 Calculation of NPV 0 1 2 3 4 5 Initial investment -481000 Cost saving 196450 196450 196450 196450 196450 Less: Tax @32% 62864 62864 62864 62864 62864 Net saving 133586 133586 133586 133586 133586 Add tax save on dep 27789 27789 27789 27789 27789 Add: Selvage value 46800 less: Tax paid on selvage -14976 Add: reduction in working capital 65000 Net cash flow -481000 420689 420689 420689 420689 517513 year Cash flow PVAF 18% Net cash flow 0 -481000 1 -481000 1 420689 0.8475 356516.1 2 420689 0.7182 302132.3 3 420689 0.6086 256044.3 4 420689 0.5158 216986.7 5 517513 0.4371 226209.7 NPV 876889.1

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