ABC Technologies $($Pty$)$ Ltd $($ABC Tech$)$ have been requested to tender for a major contract to offer a secure cloud$-$based data storage system to a fast$-$growing private college in Pretoria. ABC Tech will need, at the very least, to carry out a partial upgrade to increase existing capacity, which would cost R$70$ million. They have an option to perform a substantial upgrade at a cost of R$150$ million to the server and exploit the increasing market demand for secure data storage to increase their earning potential.

The equipment is expected to have an economic life of five years, regardless of the option that ABC Tech chooses. The finance team has prepared the following investment appraisal analysis:

OPTION $1$: Partial Upgrade YEAR $0$ YEAR $1$ YEAR $2$ YEAR $3$ YEAR $4$ YEAR $5$ R$$m R$$m R$$m R$$m R$$m R$$m

Equipment

$(70)$

Revenue

$40$

$40$

$40$

$40$

$40$

Maintenance costs

$(10)$

$(15)$

$(20)$

$(25)$

$(30)$

Net cash flow

$(70)$

$30$

$25$

$20$

$15$

$10$

NPV

R$9\mathrm{.}4$ m

Discount rate

$10\%$

IRR

$16\%$

Payback period

$2\mathrm{.}75$ years

OPTION $2$: Substantial upgrade YEAR $0$ YEAR $1$ YEAR $2$ YEAR $3$ YEAR $4$ YEAR $5$ R$$m R$$m R$$m R$$m R$$m R$$m

Equipment

$(150)$

Revenue

$50$

$60$

$70$

$80$

$90$

Maintenance costs

$(15)$

$(20)$

$(25)$

$(30)$

$(35)$

Net cash flow

$(150)$

$35$

$40$

$45$

$50$

$55$

NPV

R$17\mathrm{.}0$ m

Discount rate

$10\%$

IRR

$14\%$

Payback period

$3\mathrm{.}67$ yearsMinimum targets:

NPV: Nil

IRR: $10\%$

Payback period: $3$ years REQUIRED Marks

$($a$)$

Provide an interpretation of the results of the investment appraisal analysis and recommend the most financial beneficial option.

$(10)$

$($b$)$

Discuss any other issues that ABC Tech should consider before making the final decision.

$(5)$

$($c$)$

Explain how a weighted average cost of capital $($WACC$)$ is calculated.

$(5)$

$($d$)$

Discuss various ways that ABC Tech could raise finance to fund the server upgrade.

$(5)$