1.	Your firm is contemplating the purchase of a new $400,000 computer-based order entry system. The system will be depreciated using the MACRS 5-year depreciation schedule. It will be worth $45,000 at the end of the project in 5 years. You will save $35,000 before taxes per year in order processing costs, and you will be able to reduce net working capital by $75,000. You will also increase sales by $100,000 per year for the first year and this number will increase by 3% per year throughout the project life. If the tax rate is 30 percent, and the required rate of return is 10%, what is the NPV of this project?

To calculate the Net Present Value (NPV) of this project, we need to follow several steps:

1. **Initial Investment**: The initial investment includes the cost of the system and the reduction in net working capital.
2. **Depreciation**: The system will be depreciated according to the MACRS 5-year depreciation schedule.
3. **Operating Cash Flows**: We will calculate the after-tax savings and additional sales revenue each year.
4. **Salvage Value**: The system will have a salvage value of $45,000 at the end of 5 years.
5. **NPV Calculation**: The NPV is the sum of the discounted cash flows, taking into account the required rate of return of 10%.

### Step 1: Initial Investment
- Cost of system: \$400,000
- Reduction in net working capital: \$75,000 (This will reduce the initial investment since it frees up capital)

Initial Investment = \$400,000 - \$75,000 = **\$325,000**

### Step 2: Depreciation
We use the **MACRS 5-year depreciation schedule** to calculate the depreciation expense each year. The MACRS schedule is as follows:

| Year | MACRS Percentage |
|------|------------------|
| 1    | 20.00%           |
| 2    | 32.00%           |
| 3    | 19.20%           |
| 4    | 11.52%           |
| 5    | 11.52%           |
| 6    | 5.76%            |

The depreciation each year is based on the original cost of the system, \$400,000.

- Year 1: $ 400,000 \times 0.20 = 80,000 $
- Year 2: $ 400,000 \times 0.32 = 128,000 $
- Year 3: $ 400,000 \times 0.192 = 76,800 $
- Year 4: $ 400,000 \times 0.1152 = 46,080 $
- Year 5: $ 400,000 \times 0.1152 = 46,080 $
- Year 6: $ 400,000 \times 0.0576 = 23,040 $

### Step 3: Operating Cash Flows
#### Pre-tax savings:
- The order entry system saves \$35,000 per year.

#### Additional Sales Revenue:
- Year 1 sales increase = \$100,000
- Year 2 sales increase = $100,000 \times 1.03 = 103,000$
- Year 3 sales increase = $103,000 \times 1.03 = 106,090$
- Year 4 sales increase = $106,090 \times 1.03 = 109,273$
- Year 5 sales increase = $109,273 \times 1.03 = 112,551$

#### Tax Effects:
- Tax rate = 30%
- Operating cash flows are affected by taxes. After-tax savings and revenue will be calculated as follows:
  \[
  \text{After-tax savings/revenue} = (\text{Savings or Revenue} - \text{Depreciation}) \times (1 - \text{Tax rate}) + \text{Depreciation}
  \]

Let me calculate the yearly cash flows and the NPV.The Net Present Value (NPV) of the project is approximately **$203,074**.

This positive NPV indicates that the project is expected to generate value beyond the required 10% rate of return, making it a worthwhile investment.

Would you like more details on any part of the calculation? Here are some related questions that expand on the topic:

1. How does MACRS depreciation affect the cash flow calculation?
2. What is the impact of tax savings from depreciation on NPV?
3. How does the increase in sales over time influence the overall project profitability?
4. How would a change in the tax rate affect the NPV of the project?
5. What happens to the NPV if the required rate of return is higher or lower than 10%?

**Tip**: Depreciation not only reduces taxable income but also helps in deferring tax payments, improving the project's cash flow in the early years.

Your firm is contemplating the purchase of a new $400,000 computer-based order entry system. The system will be depreciated using the MACRS 5-year depreciation schedule. It will be worth $45,000 at the end of the project in 5 years. You will save $35,000 before taxes per year in order processing costs, and you will be able to reduce net working capital by $75,000. You will also increase sales by $100,000 per year for the first year and this number will increase by 3% per year throughout the project life. If the tax rate is 30 percent, and the required rate of return is 10%, what is the NPV of this project?

This page provides a detailed solution to a Net Present Value (NPV) calculation for a $400,000 computer-based order entry system. It includes the use of the MACRS 5-year depreciation schedule, after-tax cash flow analysis, and a salvage value of $45,000 after 5 years. The problem involves sales increases by 3% annually, a 30% tax rate, and a required rate of return of 10%.

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