Capital Budgeting : NPV Method
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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.
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Solution Summary
There are two problems. Solutions to these problems depict the methodology to calculate NPV's in the given cases.
Education
- BEng (Hons) , Birla Institute of Technology and Science, India
- MSc (Hons) , Birla Institute of Technology and Science, India
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