Question

Your firm is contemplating the purchase of a new $666,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $64,800 at the end of that time. You will be able to reduce working capital by $90,000 (this is a one-time reduction). The tax rate is 33 percent and your required return on the project is 17 percent and your pretax cost savings are $191,700 per year.

Requirement 1:

What is the NPV of this project?

$-44,325.31 $-43,411.39 $-47,981.01 $-47,067.09 $-45,696.20

Requirement 2:

What is the NPV if the pretax cost savings are $266,250 per year?

$119,811.66 $110,683.15 $117,529.53 $108,401.02 $114,106.34

Requirement 3:

At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?

$236,424.95 $223,668.78 $186,677.98 $213,017.88 $202,366.99

Answer 1

1

Time line		0	1	2	3	4	5
Cost of new machine		-666000
Initial working capital		90000
=Initial Investment outlay		-576000
Savings			191700	191700	191700	191700	191700
-Depreciation	Cost of equipment/no. of years		-133200	-133200	-133200	-133200	-133200
=Pretax cash flows			58500	58500	58500	58500	58500
-taxes	=(Pretax cash flows)*(1-tax)		39195	39195	39195	39195	39195
+Depreciation			133200	133200	133200	133200	133200
=after tax operating cash flow			172395	172395	172395	172395	172395
reversal of working capital							-90000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						43416
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							-46584
Total Cash flow for the period		-576000	172395	172395	172395	172395	125811
Discount factor=	(1+discount rate)^corresponding period	1	1.17	1.3689	1.601613	1.8738872	2.192448
Discounted CF=	Cashflow/discount factor	-576000	147346.1538	125936.88	107638.36	91998.6	57383.8
NPV=	Sum of discounted CF=	-45696.2002

2

Time line		0	1	2	3	4	5
Cost of new machine		-666000
Initial working capital		90000
=Initial Investment outlay		-576000
Savings			266250	266250	266250	266250	266250
-Depreciation	Cost of equipment/no. of years		-133200	-133200	-133200	-133200	-133200
=Pretax cash flows			133050	133050	133050	133050	133050
-taxes	=(Pretax cash flows)*(1-tax)		89143.5	89143.5	89143.5	89143.5	89143.5
+Depreciation			133200	133200	133200	133200	133200
=after tax operating cash flow			222343.5	222343.5	222343.5	222343.5	222343.5
reversal of working capital							-90000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						43416
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							-46584
Total Cash flow for the period		-576000	222343.5	222343.5	222343.5	222343.5	175759.5
Discount factor=	(1+discount rate)^corresponding period	1	1.17	1.3689	1.601613	1.8738872	2.192448
Discounted CF=	Cashflow/discount factor	-576000	190037.1795	162424.94	138824.73	118653.62	80165.868
NPV=	Sum of discounted CF=	114106.3416

3

Time line		0	1	2	3	4	5
Cost of new machine		-666000
Initial working capital		90000
=Initial Investment outlay		-576000
Savings			213017.88	213017.88	213017.88	213017.88	213017.88
-Depreciation	Cost of equipment/no. of years		-133200	-133200	-133200	-133200	-133200
=Pretax cash flows			79817.88	79817.88	79817.88	79817.88	79817.88
-taxes	=(Pretax cash flows)*(1-tax)		53477.9796	53477.98	53477.98	53477.98	53477.98
+Depreciation			133200	133200	133200	133200	133200
=after tax operating cash flow			186677.9796	186677.98	186677.98	186677.98	186677.98
reversal of working capital							-90000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						43416
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							-46584
Total Cash flow for the period		-576000	186677.9796	186677.98	186677.98	186677.98	140093.98
Discount factor=	(1+discount rate)^corresponding period	1	1.17	1.3689	1.601613	1.8738872	2.192448
Discounted CF=	Cashflow/discount factor	-576000	159553.8287	136370.79	116556.23	99620.713	63898.426
NPV=	Sum of discounted CF=	0