Question

Your firm is contemplating the purchase of a new $850,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5 year life. It will be worth $75,000 at the end of that time. You will save $320,000 before taxes per year in order processing costs and you will be able to reduce working capital by $105,000 (this is a one-time reduction). the net working capital will be restored to its original level when the project ends.The tax rate is 35%. Assume the discount rate 10%.

A) What is the annual OCF for the project?

B)What is the CAPEX BEFORE THE PROJECT STARTS (i.e.,at t=0)and when the project ends?

C) What is change in NWC before the project stars (i.e.,at t=0) and when the project ends ??

D) What are the cash flows in each year for this project??

E) What is the IRR for this project?

F) What is the NPV for this project?

plz answers with showing your work AND THE FORMULA

Answer 1

Initial Investment = $850,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $850,000 / 5
Annual Depreciation = $170,000

Initial Investment in NWC = -$105,000

Salvage Value = $75,000

After-tax Salvage Value = $75,000 * (1 - 0.35)
After-tax Salvage Value = $48,750

Annual Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $320,000 * (1 - 0.35) + 0.35 * $170,000
Annual Operating Cash Flow = $320,000 * 0.65 + 0.35 * $170,000
Annual Operating Cash Flow = $267,500

Answer a.

Annual OCF = $267,500

Answer b.

At t = 0:

CAPEX = -Initial Investment
CAPEX = -$850,000

At t = 5:

CAPEX = After-tax Salvage Value
CAPEX = $48,750

Answer c.

At t = 0:

Change in NWC = $105,000

At t = 5:

Change in NWC = -$105,000

Answer d.

Year 0:

Cash Flows = -$850,000 + $105,000
Cash Flows = -$745,000

Year 1:

Cash Flows = $267,500

Year 2:

Cash Flows = $267,500

Year 3:

Cash Flows = $267,500

Year 4:

Cash Flows = $267,500

Year 5:

Cash Flows = $267,500 - $105,000 + $48,750
Cash Flows = $211,250

Answer e.

Let IRR be i%

NPV = -$745,000 + $267,500/(1+i) + $267,500/(1+i)^2 + $267,500/(1+i)^3 + $267,500/(1+i)^4 + $211,250/(1+i)^5
0 = -$745,000 + $267,500/(1+i) + $267,500/(1+i)^2 + $267,500/(1+i)^3 + $267,500/(1+i)^4 + $211,250/(1+i)^5

Using financial calculator, i = 22.0%

IRR of the project is 22.0%

Answer f.

Discount Rate = 10%

NPV = -$745,000 + $267,500/1.10 + $267,500/1.10^2 + $267,500/1.10^3 + $267,500/1.10^4 + $211,250/1.10^5
NPV = $234,108.64