Question

The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small business computer system. The initial investment will be $35,000 and the hardware, which will be used for 10 years with a salvage value of $5,000, and software of $20,000. In each of years 3, 5, and 7, $5,000 will be spent for additional software. Hardware has a CCR rate 45 percent and software is class 12 (100 percent). The computer system is expected to provide additional revenue of $15,000 per year for the next 10 years, and to reduce expenses by $10,000 per year for the same period. The firm's cost of capital is 12 percent and its tax rate is 40 percent. Based on a net present value analysis, should this investment be accepted?

Answer 1

Year	0	1	2	3	4	5	6	7	8	9	10
1.Initial Investment in hardware	-35000
2.Investment in software	-20000			-5000		-5000		-5000
3.After-tax salvage of hardware(5000*(1-40%))											3000
Operating cash flows:
4.Incremental revenues		15000	15000	15000	15000	15000	15000	15000	15000	15000	15000
5.Savings in expenses		10000	10000	10000	10000	10000	10000	10000	10000	10000	10000
6.Depn. -Hardware At CCR(as in Table)		-15750	-8663	-4764	-823
7.100% Software depn.( End-of-Year respective investment Cash flows)		-20000			-5000		-5000		-5000
8.EBT(4+5+6+7)		-10750	16337.5	20235.63	19177	25000	20000	25000	20000	25000	25000
9.Tax at 40%(8*40%)		4300	-6535	-8094	-7671	-10000	-8000	-10000	-8000	-10000	-10000
10.EAT(8-9)		-6450	9802.5	12141	11506	15000	12000	15000	12000	15000	15000
11.Add Back: dpen.(6+7)		35750	8663	4764	5823	0	5000	0	5000	0	0
12.Operating cash flows(10+11)		29300	18465	16906	17329	15000	17000	15000	17000	15000	15000
13.Net annual FCFs(1+2+3+12)	-55000	29300	18465	11906	17329	10000	17000	10000	17000	15000	18000
14.PV F at 12%(1/1.12^Yr.n)	1	0.89286	0.79719	0.71178	0.63552	0.56743	0.50663	0.45235	0.40388	0.36061	0.32197
15.PV at 12%(13*14)	-55000	26160.71	14720.18	8474.28	11013.02	5674.27	8612.73	4523.49	6866.01	5409.15	5795.52
16.NPV(sum of Row 15 )	42249.37
Decision:
The investment CAN be ACCEPTED
as it's NPV is POSITIVE

Year	Capital Cost Recovery(UCC*45%)	Undepreciated Capital Cost(Prev. bal.-Current CCR)
0		35000
1	15750	19250
2	8663	10588
3	4764	5823
4	823	5000
		(Salvage)