Question

eEgg is considering the purchase of a new distributed network computer system to help handle its warehouse inventories. The system costs $40,000 to purchase and install and $29,000 to operate each year. The system is estimated to be useful for 4 years. Management expects the new system to reduce the cost of managing inventories by $50,000 per year. The firm's cost of capital (discount rate) is 9%. Required: 1. What is the net present value (NPV) of the proposed investment under each of the following independent situations? (Use the appropriate present value factors from Appendix C, TABLE 1 and Appendix C, TABLE 2.) 1a. The firm is not yet profitable and therefore pays no income taxes. 1b. The firm is in the 27% income tax bracket and uses straight-line (SLN) depreciation with no salvage value. Assume MACRS rules do not apply. 1c. The firm is in the 27% income tax bracket and uses double-declining-balance (DDB) depreciation with no salvage value. Given a four-year life, the DDB depreciation rate is 50% (i.e., 2 x 25%). In year four, record depreciation expense as the net book value (NBV) of the asset at the start of the year. 2. What is the internal rate of return (IRR) of the proposed investment for situations in requirement 1. parts (a) through (c)? Use the IRR built-in function in Excel to compute the IRR. Complete this question by entering your answers in the tabs below. Req 1A Reg 1B Req 1C Reg 2 The firm is in the 27% income tax bracket and uses double-declining-balance (DDB) depreciation with no salvage value. Given a four-year life, the DDB depreciation rate is 50% (i.e., 2 x 25%). In year four, record depreciation expense as the net book value (NBV) of the asset at the start of the year. (Negative amounts should be indicated by a minus sign. Round discount factor to 3 decimal places and other answers to the nearest whole dollar amount.) Show less Year Pre-Tax Cash Inflows DDB Depreciation Expense Taxable Income Present Values $ $ 0 1 21 (40,000) (29,000) (29,000) (29,000) (29,000) 20,000 10,000 5,000 5,000 21,000 21,000 21,000 21,000 Income After-tax Net Discount Taxes Cash Inflow Factor $ (40,000) 1.000 5,400 26,410 0.917 2,700 23,690 0.842 1,350 22,360 0.772 1,350 22,360 0.708 Net present value (NPV) = (40,000) 24,220 19,950 17,260 15,830 37,260 3 4 $ Req 1B Req2 >

Answer 1

Solution:

Year	Pre -Tax Cash inflows (a)	DDB Depreciation Expense (b)	Taxable Income(c=a-b)	Income Taxes @27%(d)	After-Tax Net Cash inflows ( c-d+b)	Discount Factor	Present Values
0	$       (40,000)				$                     (40,000)	1	$ (40,000)
1	$         21,000	$           20,000	$                  1,000	$        270	$                       20,730	0.917	$   19,018
2	$         21,000	$           10,000	$               11,000	$    2,970	$                       18,030	0.842	$   15,175
3	$         21,000	$             5,000	$               16,000	$    4,320	$                       16,680	0.772	$   12,880
4	$         21,000	$             5,000	$               16,000	$    4,320	$                       16,680	0.708	$   11,817
					Net Present Value (NPV)		$   18,890