Question

Market Top Investors, Inc., is considering the purchase of a $385,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method, at which time it will be worth $30,000. The computer will replace two office employees whose combined annual salaries are $90,000. The machine also will immediately lower the firm’s required net working capital by $70,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 22 percent. Is it worthwhile to buy the computer if the appropriate discount rate is 9 percent?

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-385000
Initial working capital		70000
=Initial Investment outlay		-315000
Savings			90000	90000	90000	90000	90000
-Depreciation	Cost of equipment/no. of years		-77000	-77000	-77000	-77000	-77000
=Pretax cash flows			13000	13000	13000	13000	13000
-taxes	=(Pretax cash flows)*(1-tax)		10140	10140	10140	10140	10140
+Depreciation			77000	77000	77000	77000	77000
=after tax operating cash flow			87140	87140	87140	87140	87140
reversal of working capital							-70000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						23400
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							-46600
Total Cash flow for the period		-315000	87140	87140	87140	87140	40540
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816	1.538624
Discounted CF=	Cashflow/discount factor	-315000	79945	73343.99	67288.068	61732.173	26348.218
NPV=	Sum of discounted CF=	-6342.591513

NPV is negative, do not buy