The president of Big Fish 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 Big Fish 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 Big Fish Games acquire the equipment? Show computations.
3. Ignore number 2. Suppose the required after-tax rate of return is 10% instead of 14%. Should Big Fish Games acquire the equipment? Show computations.