question archive In this section, you need to evaluate two investment alternatives #1 and # 2
In this section, you need to evaluate two investment alternatives #1 and # 2
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In this section, you need to evaluate two investment alternatives #1 and # 2.
The X department (in your company) suggests purchasing new computer software to
reduce costs. There are two competitive software in the market, alternative #1, $194,000
and # 2, $336,000.
Based on the Canadian Tax Act, software should be depreciated with a CCA of 30%. After five years, the salvage value of either investment is 0. IT would hire a professional adviser under either investment alternative to help in the decision making whether to invest in the alternative for a fee of $25,000 and this fees will be expensed when it is incurred. In Addition, IT would charge X department the use of computer time at the rate of $394, for an estimated of 182 hours of computer time per year to run the new software under either alternative, #1 or #2. You were informed that the discount rate is 15%. The corporate tax of your company is 35%.
Below is the saving (before tax) generated by each investment alternative
Year #1 #2
1 $86,000 $118,000
2 $86,000 $130,000
3 $67,000 $106,000
4 $56,000 $98,000
5 $39,000 $59,000
This section requires to show detail calculations. Which investment alternative do you
select? Why? If calculations are not presented, the grade will be zero.
This question pertains to How to Make Capital Investment Decisions
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ANSWER:
1 $86,000 $118,000
2 $86,000 $130,000
3 $67,000 $106,000
4 $56,000 $98,000
5 $39,000 $59,000
Step-by-step explanation
There are two alternatives with $195000 and $336000 initial cost respectively
we need to calculate the NPV for both investments
PV=CF(1+r)^-n
Alternative 1
year 1 = 86000*(1+0.15)^-1 = 74782.6086
year 2 = 86000*(1+0.15)^-2 = 65028.3554
year 3 = 67000*(1+0.15)^-3 = 44053.5875
year 4 = 56000*(1+0.15)^-4 = 32018.1817
year 5 = 39000*(1+0.15)^-5 = 19389.8926
Total NPV = 235272.63
less initial capital 195000
= 235272.63 - 195000)
Profit before tax = 40272.63
Alternative 2
year 1 = 118000*0.86956 = 102608.8
year 2 = 130000*0.75614 =98298.2
year 3 = 106000*0.65751 =69696.06
year 4 = 98000*0.57175 = 56031.50
year 5 = 59000*49117 = 29333.03
Total NPV = 355966.81
less initial capital 336000
= 355966.81-336000
Profit before tax = 19966.81
The NPV of Alternative 2 is greater than the NPV of alternative 1, Therefore investment alternative two should be selected
NPV refers to Net Present value
