Problem
Payback Period and NPV:
Taxes and Straight-Line Depreciation
Assume that United Technologies is evaluating a proposal to change the company's manual design system to a computer-aided design (CAD) system. The proposed system is expected to save 10,000 design hours per year; an operating cost savings of $50 per hour. The annual cash expenditures of operating the CAD system are estimated to be $250,000. The CAD system requires an initial investment of $500,000. The estimated life of this system is five years with no salvage value. The tax rate is 40 percent, and United Technologies uses straight-line depreciation for tax purposes. United Technologies has a cost of capital of 20 percent.
(a) Compute the annual after-tax cash flows related to the CAD project.
(b) Compute each of the following for the project:
1. Payback period.
2. Net present value.