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# Capital Budgeting : NPV Method

Problem 1
The president of E-Games, an online gaming company, is considering the purchase of some equipment used for the development of new games. The cost is \$400,000, the economic life and the recovery period are both 5 years, and there is no terminal disposal value. Annual pretax cash inflows from operations would increase by \$130,000, giving a total 5-year pretax savings of \$650,000. The income tax rate is 40%, and the required after-tax rate of return is 14%.

1. Compute the NPV, assuming straight-line depreciation of \$80,000 yearly for tax purposes. Should E-Games acquire the equipment?
2. Suppose the asset will be fully depreciated at the end of year 5 but is sold for \$25,000 cash. Should E-Games acquire the equipment? Show computations.
3. Ignore number 2. Suppose the required after-tax rate of return is 10% instead of 14%. Should E-Games acquire the equipment? Show computations.

Problem 2
The head of the oncology department of FH Research Center is considering the purchase of some new equipment. The cost is \$420,000, the economic life is 5 years, and there is no disposal value. Annual cash flows from operations would increase by \$140,000, and the required rate of return is 14%. There are no taxes.
1. Compute the NPV.
2. Should the research center acquire the equipment? Explain.

#### Solution Summary

There are two problems. Solutions to these problems depict the methodology to calculate NPV's in the given cases.

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