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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?

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    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.

    $2.19

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