Question

Pappy’s Potato is contemplating the purchase of a new $495,000 computer-based order entry system. The company plans to use this new system for the next 6 years. However, the system will be depreciated straight-line to zero over the next nine-year life. At the end of the 6th year, the system will be sold for an expected liquidation value of $45,000. You will save $235,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $65,000 at the beginning of the project. Working capital will revert back to normal at the end of the 6th year when the project will be terminated. If the tax rate is 35 percent and the required rate of return for the project is 18%, what is the NPV for this project?

Answer 1

Statement showing NPV

Particulars	0	1	2	3	4	5	6	NPV = sum of PV
Cost of computer-based order entry system	-495000
Reduction in WC	65000
Before tax savings in order processing cost		235000	235000	235000	235000	235000	235000
Depreciation (495000/9)		-55000	-55000	-55000	-55000	-55000	-55000
PBT		180000	180000	180000	180000	180000	180000
Tax @ 35%		-63000	-63000	-63000	-63000	-63000	-63000
PAT		117000	117000	117000	117000	117000	117000
Add: Depreciation		55000	55000	55000	55000	55000	55000
Annual cash flow		172000	172000	172000	172000	172000	172000
Increase in WC							-65000
Cash flow from sale of machine (Note 1)							87000
Total cash flow	-430000	172000	172000	172000	172000	172000	194000
PVIF @ 18%	1.0000	0.8475	0.7182	0.6086	0.5158	0.4371	0.3704
PV	-430000.00	145762.71	123527.72	104684.51	88715.69	75182.79	71863.72	179737.13

Thus NPV = $179,737.13

Note 1) Statement showing Cash flow from sale of machine

Particulars	Amount
Salage value at end of year 6	45000
Book value ast end of year 6 (495000 - (6x55000)) = 495000 -330000 =165000	165000
Loss	120000
Tax Savings @35%	42000
Cash flow from sale of machine (45000+42000)	87000