RightPrice Investors, Inc., is considering the purchase of a $362,000 computer w

Question

RightPrice Investors, Inc., is considering the purchase of a $362,000 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 $62,000 in four years. The computer will replace 4 office employees whose combined annual salaries are $107,000. The machine will also immediately lower the firm’s required net working capital by $82,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 34 percent. The appropriate discount rate is 10 percent. calculate NPV of this project.

Explanation / Answer

Initial investment =Purchase cost -decrease in working capital

             = 362000- 82000

            = 280000

**depreciation = 362000/4 = 90500

Book value at end of year 4 = 0

Gain on sale =sale value- book value

          = 62000-0

        = 62000

tax on gain = 62000*.34 = 21080

After tax sale value = 62000-21080 = 40920

3)Annual net savings before tax = 107000- 90500 depreciation = 16500

Income after tax = 16500[1-.34] = 10890

Annual cash flow - 10890 +90500 depreciation (non cash) = 101390

4)Terminal value = after tax sale value - investment in working capital(since need to be replaced)

        = 40920- 82000

        = -41080

present value of cash flow =[PVA 10%,4 * Annual cash flow ] + [PVF 10%,4 * Terminal value]

=[3.16987*101390]+[ .68301*-41080]

= 321393.12- 28058.05

= 293335.07

NPV =Present value -initial cost

= 293335.07- 280000

= 13335.07

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