Problem: A manager of Olympic Mutual Funds is contemplating acquiring servers to operate its Website. The servers will cost $660,000 cash and will have zero terminal salvage value. The recovery period and useful life are both 3 years. Annual pretax cash savings from operations will be $300,000. The income tax rate is 40%, and the required after-tax rate of return is 12%.
Q1. Compute the NPV, assuming straight-line depreciation of $220,000 yearly for tax purposes. Should Olympic acquire the computers? Explain.
Q2. Suppose the computers will be fully depreciated at the end of the year 3 but can be sold for $90,000 cash. Compute the NPV. Should Olympic acquire the computers? Explain.
Q3. Ignore number 2. Suppose the required after-tax rate of return is 8% instead of 12%. Should Olympic acquire the computers? Show Computations.