Question

Market Top Investors, Inc., is considering the purchase of a $340,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method, at which time it will be worth $54,000. The computer will replace two office employees whose combined annual salaries are $85,000. The machine will also immediately lower the firm’s required net working capital by $74,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 24 percent. The appropriate discount rate is 11 percent.

  

Calculate the NPV of this project. Is it worth it to buy this computer?

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-340000
Initial working capital		74000
=Initial Investment outlay		-266000
								100.00%
Savings			85000	85000	85000	85000	85000
-Depreciation	Cost of equipment/no. of years		-68000	-68000	-68000	-68000	-68000	0	=Salvage Value
=Pretax cash flows			17000	17000	17000	17000	17000
-taxes	=(Pretax cash flows)*(1-tax)		12920	12920	12920	12920	12920
+Depreciation			68000	68000	68000	68000	68000
=after tax operating cash flow			80920	80920	80920	80920	80920
reversal of working capital							-74000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						41040
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							-32960
Total Cash flow for the period		-266000	80920	80920	80920	80920	47960
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704	1.6850582
Discounted CF=	Cashflow/discount factor	-266000	72900.9009	65676.487	59168.007	53304.51	28461.926
NPV=	Sum of discounted CF=	13511.83

Buy computer as NPV is positive