Case Question

Delmon United is an IT solutions firm based in Silicon Valley, USA. The company want to improve their IT solution business by improving their bigdata and supercomputers. In doing so, the company can be either upgrade the original version or replace with new version. Delmon United will acquire bigdata and supercomputers by using the most efficient way. Delmon United is in the 50% tax bracket and cost of capital of 25%.

The conditions of the upgrade the original version or replace with the new version for bigdata facilities and supercomputers are as follows:

Upgrade the original version:

• Initial cost of old big data = $ 120,000
• Annual depreciation of $ 12,000
• The old big data facilities were purchased 5 years ago
• The current book value of old bigdata = $ 60,000
• The salvage value of old bigdata (today) = $ 65,000
• The salvage value in 5 years = $ 5,000

Replace with the new version:

• Initial cost of new bigdata = $ 200,000
• Its anticipated to have 5 years life
• The salvage value in 5 years = $ 0
• Cost savings per year = $ 80,000 per year
• The company will use 3-years MACRS depreciation.

Answer the following questions (Note: kindly show ALL the necessary steps/calculations. LESS mark will be given if you failed to show the steps/calculations)

1. 1. Calculate the depreciation expense for new bigdata (Yr.1 Yr.5) using MACRS method
   2. Calculate the projected net income (Yr.1 Yr.5)
   3. Find the after-tax salvage value of old big data in Yr.0
   4. Calculate incremental net capital spending in Yr.0
   5. Find the after-tax salvage value of old big data in Yr.5
   6. Calculate the operating cash flows (OCF) from Yr.1 Yr.5
   7. Calculate the total cash flow (or cash flow from assets CFFA) from Yr.0 Yr.5
   8. Calculate the NPV and IRR (you may use financial calculator)
   9. What is your advice to Delmon United? Should they replace bigdata with the new version?
2. 10. Without calculation, use the IRR criteria to explain why the Delmon United should accept or reject the new data project if the cost of capital is increased to 30%, 35%, or 40 %.

Cost of capital	Decision	Why? (use IRR criteria to explain the decision)
30%	accept or reject?
35%	accept or reject?
40%	accept or reject?

TABLE 1 Year 15-Year 20-Year 5.00% 9.50 8.55 MACRS Half-Year Convention Depreciation Rate for Recovery Period 3-Year 5-Year 7-Year 10-Year 33.33% 20.00% 14.2995 10.0096 44.45 32.00 24.49 18.00 14.81 19.20 17.49 14.40 7.41 11.52 12.49 11.52 11.52 8.93 9.22 5.76 8.92 7.37 8.93 6.55 4.46 6.55 6.56 6.55 3.28 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 7.70 6.93 6.23 5.90 5.90 5.91 5.90 5.91 5.90 5.91 5.90 5.91 2.95 3.750% 7.219 6.677 6.177 5.713 5.285 4.888 4.522 4.462 4.461 4.462 4.461 4.462 4.461 4.462 4.461 4.462 4.461 4.462 4.461 2.231