MANAGEMENT 122 MANAGEMENT ACCOUNTING

FALL 2012 DANNY S. LITT

CASE ASSIGNMENT 2
You have been asked to help a local company evaluate a major capital expenditure. The company is a new internet company and must buy a large computer system which will generate additional revenue. The company provides you with the following information: Initial cost of project Depreciation method Salvage value Residual value (sales price at end of project) Tax rate (ordinary and capital gains tax) Incremental annual revenues in year 1 Incremental annual expenses in year 1 Working capital required at time of investment (t=0) Working capital as percentage of revenue each year Cost of capital Economic life $1,000,000 Straight-line $50,000 $65,000 35% $180,000 $47,500 $5,000 2.0% 8% 10 years

Requirements: a. Write a letter to the president of the company explaining whether the company should acquire the computer system. Utilize both NPV and IRR. Assume that the initial $180,000 in annual revenues will grow at a 6% annual rate and that the initial $47,500 in annual expenses will grow at a 5% annual rate. The growth starts in year 2 from year 1, i.e. the revenue is year 2 is 190,800, etc. Working capital is released at the end of the project. b. Redo this analysis above using sum-of-years digits depreciation method. What happens to the results and would you change your recommendation? c. Redo this analysis above using MACRS (10 years) depreciation method. What happens to the results and would you change your recommendation?

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