Question

FInance

Alt's is contemplating the purchase of a new $218,000 computer-based order entry system.
The system will be depreciated straight-line to zero over the system's five-year life. The
system will be worth $20,000 at the end of five years. The company will save $73,500 before
taxes per year in order processing costs and will reduce working capital by $18,600 on Day
1. The net working capital will return to its original level when the project ends. The tax rate
is 21 percent. If the required return is 10%, is this a good cost cutting project?

Answer 1

Tax rate		21%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		$         218,000	$      218,000	$       218,000	$            218,000	$      218,000
Dep Rate= 1/5=20%		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation	Cost * Dep rate	$           43,600	$        43,600	$         43,600	$              43,600	$        43,600	$             218,000
Calculation of after-tax salvage value
Cost of machine			$      218,000
Depreciation			$      218,000
WDV	Cost less accumulated depreciation	$                -
Sale price			$        20,000
Profit/(Loss)	Sale price less WDV	$        20,000
Tax	Profit/(Loss)*tax rate	$          4,200
Sale price after-tax	Sale price less tax		$        15,800
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
Contribution		$           73,500	$        73,500	$         73,500	$              73,500	$        73,500
Less: Depreciation		$           43,600	$        43,600	$         43,600	$              43,600	$        43,600
Profit before tax (PBT)		$           29,900	$        29,900	$         29,900	$              29,900	$        29,900
Tax@21%	PBT*Tax rate	$             6,279	$          6,279	$           6,279	$                6,279	$          6,279
Profit After Tax (PAT)	PBT - Tax	$           23,621	$        23,621	$         23,621	$              23,621	$        23,621
Add Depreciation	PAT + Dep	$           43,600	$        43,600	$         43,600	$              43,600	$        43,600
Cash Profit after-tax		$           67,221	$        67,221	$         67,221	$              67,221	$        67,221
Calculation of NPV
						10.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor	Present values
0		$        (218,000)	$       (18,600)		$           (236,600)	1.0000	$       (236,600.00)
1				$         67,221	$              67,221	0.9091	$          61,110.00
2				$         67,221	$              67,221	0.8264	$          55,554.55
3				$         67,221	$              67,221	0.7513	$          50,504.13
4				$         67,221	$              67,221	0.6830	$          45,912.85
5		$           15,800	$        18,600	$         67,221	$            101,621	0.6209	$          63,098.65
					Net Present Value		$          39,580.17