Scott Investors, Inc., is considering the purchase of a $370,000 computer with a

Question

Scott Investors, Inc., is considering the purchase of a $370,000 computer with an economic life of four years. The computer will be fully depreciated over four years using the straight-line method. The market value of the computer will be $70,000 in four years. The computer will replace 4 office employees whose combined annual salaries are $115,000. The machine will also immediately lower the firm’s required net working capital by $90,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 40 percent. The appropriate discount rate is 10 percent.

Calculate the NPV of this project.

Scott Investors, Inc., is considering the purchase of a $370,000 computer with an economic life of four years. The computer will be fully depreciated over four years using the straight-line method. The market value of the computer will be $70,000 in four years. The computer will replace 4 office employees whose combined annual salaries are $115,000. The machine will also immediately lower the firm’s required net working capital by $90,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 40 percent. The appropriate discount rate is 10 percent.

Explanation / Answer

Net Cash flows in year 0 = -370,000 + 90,000 = -280,000

Net Cash flows in years 1,2,3 = 115,000 * (1-40%) + (370,000/4) * 40% = 69,000 + 27,750 = 96,750 for each year

Net Cash flows in year 4 = (115,000 + 70,000 - 90,000) * (1-40%) + (370,000/4) * 40% = 57,000 + 27,750 = 84,750

So net cash flows are as follows

Using excel formula for NPV calculate NPV with a doscount rate of 10% = =NPV(10%,B1:B5) = 16,807.56

Note:

370,000/4* 40% is depreciation tax shield

Year 0 (280,000.00) Year 1        69,000.00 Year 2        69,000.00 Year 3        69,000.00 Year 4        57,000.00

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.