Question

Scott Investors, Inc. is considering the purchase of a $500,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method. The market value of the computer will be $100,000 in five years. The computer will replace five office employees whose combined annual salaries are $120,000. The machine will also immediately lower the firm's required net working capital by $100,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 34 percent. Is it worthwhile to buy the computer if the appropriate discount rate is 12 percent? A. Yes, NPV = $11,232 B. No, NPV = - $11,232 D. No, NPV = - $5,232 C. Yes, NPV = $5,232

Answer 1

Input			Output				Final calculation
							A	B	C = A x B
Cost of new machine	$500,000		Initial cash outlay			Year	Cash Flow	DF at 12%	PV
Years of operation	5		Investment	$       (500,000)		0	-400000	1	-400000
Pretax salvage value	$100,000		NWC	100,000		1	113200	0.892857	101071.4286
Saved salaries	$120,000		Total	$       (400,000)		2	113200	0.797194	90242.34694
Reduction in NWC	$100,000					3	113200	0.71178	80573.52405
Tax rate	34%		Incremental cash flow			4	113200	0.635518	71940.64648
Requried return	12%		Saved salaries	$120,000		5	79200	0.567427	44940.20697
*Depreciation straight-line			Depreciation	100,000			NPV = Sum total		$       (11,232)
			EBT	20,000			*(11320-34000)
			Taxes	6800
			Net Income	13,200
			Add back Depreciation	100000
			OCF	113,200
			Salvage Value
			sale of equipment	100,000
			Taxes	(34,000)
			NWC	(100,000)
			Terminal cash flow	(34,000)

Hence Ans is B No, NPV -11232