Question

Your firm is contemplating the purchase of a new $1,147,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $111,600 at the end of that time. You will be able to reduce working capital by $155,000 (this is a one-time reduction). The tax rate is 21 percent and your required return on the project is 20 percent and your pretax cost savings are $333,250 per year.

a. What is the NPV of this project?
A) $3,623.88
B) $48,475.61
C) $62,509.24
D) $76,042.87

Answer 1

The NPV of the project is $62,509.24.

Step-by-step explanation:

To calculate the NPV of the project, we need to determine the cash flows and discount them to present value. The initial investment is $1,147,000, which is the cost of the new system. The annual cost savings are $333,250 before taxes, but since there is a 21% tax rate, the after-tax cash flow is $333,250 * (1 - 0.21) = $263,677.50. We also need to consider the salvage value of $111,600 at the end of 5 years.

Using the formula for NPV:

NPV = (Initial Investment + Annual Cash Flows) * Discount Factor - Salvage Value

Discount factor = 1 - (1 + required return rate) ^ -n, where n is the number of years.

Calculating the NPV:

NPV = ($1,147,000 + $263,677.50 * ((1 - (1 + 0.2) ^ -5) / 0.2)) - $111,600 = $62,509.24

Therefore, the NPV of this project is $62,509.24.