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# Capital Budgeting

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I am evaluating a proposed acquisition of a new computer for my company. The computer's price is \$40,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in net operating working capital of \$2,000. The computer would increase the firm's before-tax revenues by \$20,000 per year but would also increase operating costs by \$5,000 per year. The computer is expected to be used for 3 years and then be sold for \$25,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent.

1) What is the net investment required at t = 0?
2) What is the operating cash flow in Year 2?
3) What is the total value of the terminal year non-operating cash flows at the end of Year 3?
4) What is the project's NPV?

#### Solution Preview

1) What is the net investment required at t = 0?

Initial investment:
Cost (\$40,000)
Change in NWC (2,000 )
Total (\$42,000)

2) What is the operating cash flow in Year 2?

Operating cash flow
Depreciation schedule:
Depreciable basis = \$40,000.
MACRS Depreciation Amount is
Year Percent Basis Depreciation
1 0.33 \$40,000 \$13,200
2 0.45 ...

#### Solution Summary

The solution explains how to calculate the project cash flows and the NPV.

\$2.49