Your firm is contemplating the purchase of a new $999,000 computer-based order e

Question

Your firm is contemplating the purchase of a new $999,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $97,200 at the end of that time. You will be able to reduce working capital by $135,000 (this is a one-time reduction). The tax rate is 32 percent and your required return on the project is 20 percent and your pretax cost savings are $430,550 per year. What is the NPV of this project? What is the NPV if the pretax savings are 310000 per year? At what level of pretex cpst savings would you be indifferent between accepting the project and not accepting it?

Explanation / Answer

Step 1:

Step 2:

Hence the NPV is $432413.75

If the pre tax savings is 310000 then the NPV will be :

step 1:

step 2:

To check whether to accept the project or not indifferent point the NPV should be zero hence we have to discount at higher than 20% considering the pretax saving 310000

Hence at 26.85% the NPV is almost zero therefore the discount rate is 26.85%

Particulars 1 2 3 4 5 Pretax savings 430550 430550 430550 430550 430550 tax32% 137776 137776 137776 137776 137776 Profit after tax 292774 292774 292774 292774 292774 Add depreciation 199800 199800 199800 199800 199800 999000/5 Cash flow=profit+dep 492574 492574 492574 492574 492574

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