Please answer part A,B,C Your firm is contemplating the purchase of a new $605,0
ID: 2633886 • Letter: P
Question
Please answer part A,B,C
Your firm is contemplating the purchase of a new $605,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $65,000 at the end of that time. You will be able to reduce working capital by $80,000 (this is a one-time reduction). The tax rate is 34 percent and the required return on the project is 14 percent.
If the pretax cost savings are $205,000 per year, what is the NPV of this project? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
a)NPV $t
If the pretax cost savings are $155,000 per year, what is the NPV of this project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
b)NPV $
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 final answer to 2 decimal places. (e.g., 32.16))
c)Cost savings $
Explanation / Answer
Annual depreciation charge = 605000/5
=$121000
The aftertax salvage value of the equipment is = 65000*(1-34%)
=$42900
Using the tax shield approach, the OCF is = 205000*(1-34%)+34%*121000
=$176440
Now we can find the project IRR. There is an unusual feature that is a part of this project. Accepting this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end of the project, we will have a cash outflow to restore the NWC to its level before the project. We also must include the aftertax salvage value at the end of the project
OCF in the year 5 = 176440+42900-80000
=$139340
NPV:
NPV is -$18535.77
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OCF when the pre tax income is 155000 = 155000*(1-34%)+34%*121000
=$143440
OCF in the year 5 = 143440+42900-80000
=$106340
NPV:
NPV is -$131827.44
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Let the pre tax income be $x
=>-605000+x*(1-34%)+34%*121000+x*(1-34%)+34%*121000+x*(1-34%)+34%*121000+x*(1-34%)+34%*121000+x*(1-34%)+34%*121000+42900-80000 = 0
=> x = $213180.55
Hence, at a pre tax income of $213180.55 the firm will be indifferent
Year cash flow present value 0 -605000 -605000 1 176440 154771.93 2 176440 135764.85 3 176440 119091.97 4 176440 104466.64 5 139340 72368.83 NPV -18535.77