IBC, Inc. is considering the purchase of a $320,000 computer that has an economi
ID: 2617328 • Letter: I
Question
IBC, Inc. is considering the purchase of a $320,000 computer that has an economic life of 5 years. The computer will be depreciated according to 5-year MACRS schedule (20%, 32%, 19.2%, 11.52%, 11.52%, and 5.76%). The market value of the computer will be $60,000 in 5 years. The use of computer will save annual costs of $120,000 for the next five years. For simplicity, these cost savings are assumed to occur at the end of these years. As a result of this project, the net working capital will increase by $60,000 immediately, and it will be recovered at the end of year 5. The firm’s tax rate is 40% and its cost of capital is 12%. | What is the initial investment requirement (t=0)? What is the operating cash for one, two, three and four and five years? How much tax is the firm expected to pay when the asset is sold for $60,000 in year 5?
What is the project's NPV?
Explanation / Answer
1. Intially Requirement (t=0)
= Cost of Computer + Increase in Working Capital = $ 320,000 + $ 60,000
= $ 380,000
2. Operating Cash Flows ( Amount in $ )
5
120,000
14,337
105,663
42,265
77,735
3. Tax Expected to pay when the asset is sold for $60,000
Depreciation schedule.
110,116
Closing Book Value = $ 110,116
Sale Value $ 60,000
Since there is a loss of $ 50,116 ( $60,000- 110,116) on sale , firm is not required to pay any tax.
4. PROJECT NPV
Year 0 1 2 3 4 5
a)Initial Outflow -380,000
b)Operating Cash Flows 97,600 104,768 85,369 78,481 77,735
c)Salvage Value 60,000
d)Working Capital Recovery 60,000
e)Total Cash flows -380,000 97,600 104,768 85,369 78,481 197,735
(a+b+c+d)
f)PVF@ 12% 1 0.893 0.797 0.712 0.636 0.567
g)Present Value -380,000 87,143 83,520 60,764 49,876 112,200
(e x g)
Net Present Value = -380,000 + 87,143 + 83,520 + 60,764 + 49,876 + 112,200
= $ 13,504
5