Your firm is contemplating the purchase of a new $490,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $38,000 at the end of that time. You will be able to reduce working capital by $63,000 (this is a one-time reduction). The tax rate is 21 percent and the required return on the project is 9 percent. If the pretax cost savings are $150,000 per year, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Will you accept or reject the project? Reject Accept If the pretax cost savings are $115,000 per year, what is the NPV of this project? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Will you accept or reject the project? Accept Reject At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Time line | 0 | 1 | 2 | 3 | 4 | 5 | |||
Cost of new machine | -490000 | ||||||||
Initial working capital | -63000 | ||||||||
=Initial Investment outlay | -553000 | ||||||||
100.00% | |||||||||
Savings | 150000 | 150000 | 150000 | 150000 | 150000 | ||||
-Depreciation | Cost of equipment/no. of years | -98000 | -98000 | -98000 | -98000 | -98000 | 0 | =Salvage Value | |
=Pretax cash flows | 52000 | 52000 | 52000 | 52000 | 52000 | ||||
-taxes | =(Pretax cash flows)*(1-tax) | 41080 | 41080 | 41080 | 41080 | 41080 | |||
+Depreciation | 98000 | 98000 | 98000 | 98000 | 98000 | ||||
=after tax operating cash flow | 139080 | 139080 | 139080 | 139080 | 139080 | ||||
reversal of working capital | 63000 | ||||||||
+Proceeds from sale of equipment after tax | =selling price* ( 1 -tax rate) | 30020 | |||||||
+Tax shield on salvage book value | =Salvage value * tax rate | 0 | |||||||
=Terminal year after tax cash flows | 93020 | ||||||||
Total Cash flow for the period | -553000 | 139080 | 139080 | 139080 | 139080 | 232100 | |||
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.09 | 1.1881 | 1.295029 | 1.4115816 | 1.538624 | ||
Discounted CF= | Cashflow/discount factor | -553000 | 127596.3303 | 117060.8535 | 107395.2784 | 98527.778 | 150849.07 | ||
NPV= | Sum of discounted CF= | 48429.32 |
Accept project as NPV is positive
Time line | 0 | 1 | 2 | 3 | 4 | 5 | |
Cost of new machine | -490000 | ||||||
Initial working capital | -63000 | ||||||
=Initial Investment outlay | -553000 | ||||||
Savings | 134239.48 | 134239.48 | 134239.48 | 134239.48 | 134239.48 | ||
-Depreciation | Cost of equipment/no. of years | -98000 | -98000 | -98000 | -98000 | -98000 | |
=Pretax cash flows | 36239.475 | 36239.475 | 36239.475 | 36239.475 | 36239.475 | ||
-taxes | =(Pretax cash flows)*(1-tax) | 28629.18525 | 28629.18525 | 28629.18525 | 28629.185 | 28629.185 | |
+Depreciation | 98000 | 98000 | 98000 | 98000 | 98000 | ||
=after tax operating cash flow | 126629.19 | 126629.19 | 126629.19 | 126629.19 | 126629.19 | ||
reversal of working capital | 63000 | ||||||
+Proceeds from sale of equipment after tax | =selling price* ( 1 -tax rate) | 30020 | |||||
+Tax shield on salvage book value | =Salvage value * tax rate | 0 | |||||
=Terminal year after tax cash flows | 93020 | ||||||
Total Cash flow for the period | -553000 | 126629.19 | 126629.19 | 126629.19 | 126629.19 | 219649.19 | |
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.09 | 1.1881 | 1.295029 | 1.4115816 | 1.538624 |
Discounted CF= | Cashflow/discount factor | -553000 | 116173.5688 | 106581.2558 | 97780.96861 | 89707.311 | 142756.9 |
NPV= | Sum of discounted CF= | 0.00 |
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