Question

Kerfuffle Corporation is considering the purchase of a new computer system. The cost for the new system, including set-up and delivery costs of $20,000, will be $2 million. The new system will provide annual before-tax cost savings of $650,000 for the next five years. The increased efficiency of the new system will lower net working capital by $150,000 today. The CCA rate on the new system will be 30%. At the end of five years, the system can be salvaged for $125,000. The firm’s required rate of return is 15%, and its marginal tax rate is 35%. What is the NPV of this cost-cutting project?

Answer 1

	Purchase price of machinery	20,00,000
	Before tax saving	6,50,000
	tax 35%	1,95,000
	After tax saving	4,55,000
WN1		Saving	Salvage value	Cash flow	PV factor	Present Value
1	Year 1	4,55,000		4,55,000	1	3,95,652
2	Year 2	4,55,000		4,55,000	1	3,44,045
3	Year 3	4,55,000		4,55,000	1	2,99,170
4	Year 4	4,55,000		4,55,000	1	2,60,148
5	Year 5	4,55,000	1,25,000	5,80,000	0	2,88,363
						15,87,378
Wn 2	Current Senario	-1,50,000
	At the end of 5 year	74,577
	Working capital change	-75,423
Wn 3	CCA rate	30%	30%
	Tax rate	35%	35%
	Factor 1	108%	100%
	Factor 2	45%	45%
	PV factor	115%	201%
	Amount	20,00,000	1,25,000
	Tax shield	4,36,232	14,501	4,21,731
Net cash flow	Savings PV	15,87,378
	Working capital change	-75,423
	Tax shield	4,21,731
	Investment made	-20,00,000
	NPV	-66,315