Capital Budgeting questoin


Jan 23, 2017
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Virgin Islands, U.S.
i have been trying this excersise for almost a week, i have checked my notes, my book and internet so i need a little help. At least with the first flow( time 0). For the first flow I'm getting 7.2 as the net income, 0 Dep, 2.5 of capital expenditures and 0 of increases in NWC. And the flow that I'm getting is 4.70 but it should be negative.

Spirit Software Inc. is a computer software company that generated 12 million in pre -tax operating income on 100 million in revenues last year; the firm is stable and does not expect revenues or operating income to change over the next 10 years. Its inventory management is in shambles and inventory as a percent of revenues amounted to 12% last year. Spirit is considering investing in a new inventory management system, which will cost $ 15 million. The inventory management system is expected to have a 10-year life, over which period it can be depreciated straight line down to a salvage value of zero. The new inventory management system is expected to have two benefits:

  • It will immediately reduce the inventory maintained of items that are least sold and lower the inventory/sales ratio to 8% (and stay at that percentage level for the life of the inventory management system)
  • By providing salespeople with updated information on what is in stock, it is expected to increase revenues to 115 million next year (and operating margins to remain unchanged). The revenues and operating income from year 2 to year 10 will remain unchanged at year 1 levels.
  • The reduction in inventory will also allow the company to sell off its existing storage facility (which has a book value of 5 million) today for $ 10 million and buy a new storage facility for 5 million. Both the old and the new storage facilities will be depreciated straight line over the next 10 years to a salvage value of zero. The firm has an income tax rate of 40%, a capital gains tax rate of 20% and a cost of capital of 10%.

    Estimate the cashflows at time 0 (today) from this investment. (2 points) Estimate the NPV of investing in the new inventory management system.
    Thank you.

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