Problem:
Company A plan considering adopting new equipment
Initial software support total cost : $30,000,000
One time internal cost for implementing new Tech(including operating and maintenance personnel cost: $10,000,000
Internal cost will be capitalized along with the $30,000,000 purchases price when determining investment required for new proposal. In addition, $10,000,000 internal costs will be amortized over the life of the project.
Anuual maintance contract (for computer equipment): $1,500,000
Equipment useful life: 10 year
Anuual maintance contract (for upgrading software): $2,500,000
Annual cost of savings may occur after implementing new system(cash inflow) :
1. Reduction in occupancy cost : $2Mil
2. Lower maintenance and repair cost $4Mil
3. Reduced labor cost, fringe benefits, and associated overhead $7Mil
4. Reduction in inventory and accounts receivable: $5,000,000
Disposal price of equipment and software program: 5,000,000 (at the end of 5 years, discount rate : 16% ) . company A does it investment evaluation on a pretax basis.
Required:
Question 1. What is the payback period for the proposal?
Question 2. Calculate the net present value of the proposal assuming Company A's normal assumptions of a 16% cost of capital and five year life. Should company A adopt the new equipment given its existing investment criteria?
Question 3. Scott White(manager ) has read an article that argues that many companies are rejecting proposals because either the discount rate is too high or the time period over which the benefits are considered is too short. He believes that Acme should use a 10% discount rate and evaluate benefits over a 10-year period (n=10, i=10%). Prepare some comments for White on the effect of making these changes in the net present value calculations.