Question

You are evaluating the possible purchase of a new computer network for improved inventory and order tracking. The system costs $80,000 and installation/site preparation costs $4,000. It has an expected life of 6 years and estimated salvage value of $1,000. This is classified as a 5- year MACRS class.

The company will borrow the full amount of initial investment (i.e. system costs and installation/site preparation costs). The bank loan interest rate is 11% APR compounded annually and the company will repay the loan in 5 equal annual payments.

Expected annual savings is $52,000 due to less inventory lost and better customer service from this improved tracking system.

There will be annual maintenance and upkeep expenses of $12,000. In addition, in year 1 there is an extra expense of $20,000 for some software customization.

The company’s tax rate is 21%. The company’s minimum attractive rate of return is 18%

a) Determine this project’s cash flows over the project life. • Use the project cash flow table

• Show supporting calculations in detail for the following:

1. Financing activities for all years -- also use the loan principal and interest table for summarizing answers for all years.

2. All depreciation values

3. All tax values (including any tax associated with salvage).

• Additionally, for Year 1, show all “simple” calculations of Taxable income, income tax, net income, and net cash flow. You do not need to show your work for these specific calculations in other years.

b) Based on present worth analysis of the net cash flows from this project, is your project acceptable and state why

Answer 1

Modified Accelerated Cost Recovery System (MACRS) Depreciation - 5 Years class
The 5-year class will be determined based upon the table given below
The total cost of machinery
System cost	$84,000
Installation	4000
Total	88000
Year	Factor	Depreciation	Book Value
1	20%	17600	70400
2	32%	28160	42240
3	19.20%	16896	25344
4	11.52%	10137.6	15206.4
5	11.52%	10137.6	5068.8
6	5.76%	5068.8	0
Note: Software customization is taken as an extra cost not included in the machinery
Now let us work out the amortization schedule
Loan amount	$84,000
Annual periodic Interest rate	11%
Loan repayment is in Five equal annual payments
Instalment amount
Year	Opening Amt	Payment	Principal	Interest	Balance
1	$84,000	($22,727.91)	($13,487.91)	($9,240.00)	$70,512.09
2	$70,512.09	($22,727.91)	($14,971.58)	($7,756.33)	$55,540.52
3	$55,540.52	($22,727.91)	($16,618.45)	($6,109.46)	$38,922.07
4	$38,922.07	($22,727.91)	($18,446.48)	($4,281.43)	$20,475.59
5	$20,475.59	($22,727.91)	($20,475.59)	($2,252.32)	$0.00
Now let us look at the company statement for the 5 years period
COST REDUCTION
Year	Realized Savings	Tax to be paid	Savings Net of Tax
1	52000	10920	41080
2	52000	10920	41080
3	52000	10920	41080
4	52000	10920	41080
5	52000	10920	41080
Depreciation tax benefit	Depreciation	Tax benefit
1	17600	3696
2	28160	5914
3	16896	3548
4	10137.6	2129
5	10137.6	2129
	5068.8	1064
all tax values
Year	Total tax paid would be
1	37384
2	35166
3	37532
4	38951
5	38951
Annual maintenance expense	12000
Extra expense in year 1	20000
Project Cash flow table	Y0	Yr1	Yr2	Yr3	Yr4	Yr5
Initial cost	84000	0	0	0	0	0
annual maintenance expenses	0	12000	12000	12000	12000	12000
Extra expense in year 1	0	20000	0	0	0	0
Tax benefit from depreciation	0	3696	5913.6	3548.16	2128.896	2128.896	1064.448
Cost reduction	0	41080	41080	41080	41080	41080
Total	84000	76776	58994	56628	55209	55209
PV of the cash flow	($84,000.00)	$65,064.41	$42,368.28	$34,465.65	$28,476.13	$24,132.32
Net present value	$110,506.79
Based upon the above analysis it makes sense to invest in the project
This part is not solved - Please try it on your own
• Additionally, for Year 1, show all “simple” calculations of Taxable income, income tax, net income, and net cash flow. You do not need to show your work for these specific calculations in other years.
Also If you want the working notes please request it additionally