Shelly’s Tax Services prepares tax returns for individuals and small businesses. The firm employs four tax professionals. Currently, all tax returns are prepared on a manual basis. The firm’s owner, Shelly Foster, is considering purchasing a computer system that would allow the firm to serve all its existing clients with only three employees. To evaluate the feasibility of the computerized system, Foster has gathered the following information:
Initial cost of the hardware and software ......... $140,000
Expected salvage value in 4 years ............... $0
Annual depreciation ................ $30,000
Incremental annual operating costs ........... $8,500
Incremental annual labor savings ........... $47,500
Expected life of the computer system .......... 4 years
Foster has determined that she will invest in the computer system if its pre-tax payback period is less than 3.5 years and its pre-tax IRR exceeds 12 percent.
a. Compute the payback period for this investment. Does the payback meet Foster’s criterion? Explain.
b. Compute the IRR for this project to the nearest percentage. Based on the computed IRR, is this project acceptable to Foster? Explain.
c. What qualitative factors should Foster consider in evaluating the project?