Question

Your firm is contemplating the purchase of a new $395,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $30,000 at the end of that time. You will be able to reduce working capital by $35,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. Assume the tax rate is 21 percent.

a.	Suppose your required return on the project is 10 percent and your pretax cost savings are $135,000 per year. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	Suppose your required return on the project is 10 percent and your pretax cost savings are $95,000 per year. What is the NPV of the project? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Net present value is calculated as present value of cash inflow less present value of cash outflow
a.
Calculation of net present value is shown below
Year	0	1	2	3	4	5
After tax cost savings 135000*(1-0.21)		$106,650	$106,650	$106,650	$106,650	$106,650
Tax shield on depreciation expense (395000/5)		$16,590	$16,590	$16,590	$16,590	$16,590
Total cash savings		$123,240	$123,240	$123,240	$123,240	$123,240
Working capital	$35,000					-$35,000
After tax salvage value (30,000*(1-0.21))						$23,700
Purchase of computer	-$395,000
Net cash flow	-$360,000	$123,240	$123,240	$123,240	$123,240	$111,940
Discount factor @ 10% (1/((1+r)^n)	1.00000	0.90909	0.82645	0.75131	0.68301	0.62092
Present value	-$360,000	$112,036	$101,851	$92,592	$84,175	$69,506
Net present value	$100,160
b.
Calculation of net present value is shown below
Year	0	1	2	3	4	5
After tax cost savings 95000*(1-0.21)		$75,050	$75,050	$75,050	$75,050	$75,050
Tax shield on depreciation expense (395000/5)		$16,590	$16,590	$16,590	$16,590	$16,590
Total cash savings		$91,640	$91,640	$91,640	$91,640	$91,640
Working capital	$35,000					-$35,000
After tax salvage value (30,000*(1-0.21))						$23,700
Purchase of computer	-$395,000
Net cash flow	-$360,000	$91,640	$91,640	$91,640	$91,640	$80,340
Discount factor @ 10% (1/((1+r)^n)	1.00000	0.90909	0.82645	0.75131	0.68301	0.62092
Present value	-$360,000	$83,309	$75,736	$68,850	$62,591	$49,885
Net present value	-$19,629