Payback Period and NPV: Taxes and Straight-Line Depreciation Assume that United Technologies Corporation is evaluating a...

Payback Period and NPV: Taxes and Straight-Line Depreciation

Assume that United Technologies Corporation is evaluating a proposal to change the company's manual design system to a computer-aided design (CAD) system. The proposed system is expected to save 13,500 design hours per year; an operating cost savings of $55 per hour. The annual cash expenditures of operating the CAD system are estimated to be $300,000. The CAD system requires an initial investment of $750,000. The estimated life of this system is five years with no salvage value. The tax rate is 35 percent, and United Technologies uses straight-line depreciation for tax purposes. United Technologies has a cost of capital of 14 percent.

(a) Compute the annual after-tax cash flows related to the CAD project. $ Answer

(b) Compute each of the following for the project:

1. Payback period. Round your answer to 2 decimal places. Answer years

2. Net present value. (Round answer to the nearest whole number.) $ Answer

Solutions

Expert Solution

Answer

Annual Saving	742,500.00
Cost	(300,000.00)
Depreciation	(150,000.00)
Net Income	292,500.00
Tax @35%	(102,375.00)
Cash Inflow after tax	190,125.00
Depreciation	150,000.00
Net Cash Inflow	340,125.00

Net Cash Inflow = $340,125 per year.

I am assuming u need to calculate Payback period using Un-Discounted Cash Inflow.

Payback period = 2 Years + ($750,000 – ($340,125 * 2)) / 190,125

Payback period = 2.37 Years

NPV
Year	Project	PVF @14%	Present Value
Initial Investment	(750,000.00)	1	(750,000.00)
Year 1	340,125.00	0.877192982	298,355.26
Year 2	340,125.00	0.769467528	261,715.14
Year 3	340,125.00	0.674971516	229,574.69
Year 4	340,125.00	0.592080277	201,381.30
Year 5	340,125.00	0.519368664	176,650.27
NPV			417,676.66

Annual Cash Inflow = $340,125

Time = 5 Years

Present Value Annuity Factor @14% for 5 Years = 3.433081 (U can calculate it on Normal Calculator or it is given in the exams)

Present Value of Cash Inflow = Annual Cash Inflow * PVAF @14% for 5 Years

= $340,125 * 3.433081

Present Value of Cash Inflow = $1,167,676.68

NPV = Present Value of Cash Inflow – Initial Investment

= $1,167,676.68– 750,000

NPV = $417,676.68

There is difference of $0.02 due to rounding off.

Dear Student, if u have any query, plz feel free to reach me.

ekkarill92 answered 2 years ago

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