Question

John's Software firm is considering the purchase of computer that has an economic life of 4

years and it is expected to have no salvage value .It will cost $ 100,000and it will be

depreciated using the straight line depreciation method .It will save the company $ 40,000the first year and it is assumed thar the savings after that will have a growth rate of 5% .It will reduce net working capital requirements by $ 10,000.The corporate tax rate is 40% and theappropriate discount rate is 14% .What is the value that the purchase will add to the firm ?

Answer 1

It is assumed that working capital saved at the beginning is reversed after four years.

NPV is:

Ref	Particulars		Year 1	Year 2	Year 3	year 4
a	Operating cash flow		$          40,000.00	$               42,000.00	$        44,100.00	$        46,305.00
b	Depreciation		$        (25,000.00)	$             (25,000.00)	$      (25,000.00)	$      (25,000.00)
c=a-b	Profit before tax		$          15,000.00	$               17,000.00	$        19,100.00	$        21,305.00
	Profit after tax		$            9,000.00	$               10,200.00	$        11,460.00	$        12,783.00
	Add depreciation		$          25,000.00	$               25,000.00	$        25,000.00	$        25,000.00
	Add: salvage value					$                      -
	Add: working capital					$      (10,000.00)
	Cash flow after tax		$          34,000.00	$               35,200.00	$        36,460.00	$        27,783.00
d	Present value factor@ 14.0%		0.877192982	0.769467528	0.674971516	0.592080277
e=c*d	Present value of annual cashflows		$          29,824.56	$               27,085.26	$        24,609.46	$        16,449.77
	Total present value of annual cash inflows		$          97,969.05
	Investment:
	Equipment		$      (100,000.00)
	Working capital		$          10,000.00
	NPV		$            7,969.05

NPV is 7,969.05