A company is considering a significant increase in the automation of its Management Information System. The hardware for the system would require an initial outlay of $3,000,000. Software and staff training costs would cost $1,000,000 per year for the first two years of operation and $200,000 per year after for the next three years. After 5 years the system would be due for replacement. The company does not believe the equipment will have any value at the end of the 5 year period. Whilst scrapping the current system will not provide any immediate cash flow, operating costs would decrease by $1,500,000 per year. The company would use a combination of debt and equity finance to pay for the new system, using its current debt to equity ratio of 25% debt to 75% equity. The company’s borrowing cost is 8% per annum, and its tax rate is 30%. The company has a cost of equity capital of 12%. 

Required 

1. Determine the Net Present Value of the proposed investment using the Weighted Average Cost of Capital. 

2. Should the company undertake it?

Answer rating: 100% (QA)

To determine the Net Present Value NPV of the proposed investment using the Weighted Average Cost of Capital WACC we need to calculate the present val... View the full answer