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Your firm is contemplating the purchase of a new $1,110,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $108,000 at the end of that time. You will be able to reduce working capital by $150,000 (this is a one-time reduction). The tax rate is 30 percent and your required return on the project is 22 percent and your pretax cost savings are $496,900 per year.
Requirement 1: What is the NPV of this project?
Requirement 2: What is the NPV if the pretax cost savings are $357,750 per year?
Requirement 3: At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?
What is the present value of the interest tax shields from this? debt?
Assuming the company has an option to abandon the project, what is the expected NPV of the project today?
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Calculate the value of a call option on the stock in the previous problem with an exercise price of 110. Verify that the put-call parity theorem is satisfied.
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