Question

MRE Sales is looking to acquire an ERP and has asked for your assistance. The company can purchase the system outright for $120,000 plus 5% sales tax, and delivery and install charges of $2,000. The ERP is expected to last 5 years and have a salvage value of $8,000. The company will use straight-line depreciation over the 5-year life. Its income tax rate is 40%. The company’s cost of capital is 12%. The system is expected to bring annual benefits of $35,000 over the 5-year period. Showing all calculations in Excel:

a. Compute the NPV of the project

b. Compute its payback period

Answer 1

Operating cash flow (OCF) each year = incremental income after tax + depreciation

profit on sale of system at end of year 5 = sale price - book value

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value - tax on profit on sale of system

NPV is calculated using NPV function in Excel

Payback period is the time taken for the cumulative cash flows to equal zero

Payback period = 2 + (cash flow required in year for cumulative cash flows to equal zero / year 3 cash flow) = 2 + ($34,800 / $46,600) = 2.75 years

NPV is $42,706