Ms. Dark the owner of Kunjan Map Plotting Inc. has decided to upgrade the existing computer network system for its office.

Three proposals for the desired equipment from various suppliers have been received. They are:

a) A rental agreement for two years at $20,500 per year, including maintenance. The agreement includes an option for an additional two years renewal including maintenance for an annual rental fee of $10,600.

b) A four-year lease with no purchase option for $13,500 per annum. The maintenance cost for the hardware and software is expected to be $2,500 for each of the first two years and $5,000 for each of the remaining years.

c) Purchasing the system hardware for $32,000. The operating system and application programs would cost $2,000 and $5,000 respectively. A software maintenance contract of $500 will apply. A salvage value of $750 is expected for the equipment at the end of its economic life.

The Company is currently reviewing each of the above proposals. Regardless of the selected alternative, the Company intends to replace the entire computer network at the end of four years as it is expected to be technologically obsolete.

The office manager believes that insurance for the new system will cost $100 annually and he anticipates that this amount will increase by 10% each year.

The Company’s tax rate is 46% and its cost of capital is 10% (i.e. use 10% after-tax discount factor).

Assuming that all cash flows are at the end of the year except for the purchase of the equipment or where otherwise stated, the application software (programs) is depreciated on a straight-line basis over two years and the computer hardware and systems software are depreciated on a declining balance basis at 30% per annum, recommend the most viable alternative. Ignore tax savings resulting from depreciation charges beyond year 4.

Show work, and explain.

Answer rating: 100% (QA)

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