Question B: If the vendors manage to develop the new generation of equipment, should the shipping department purchase the current generation and then sell it back to the manufacturer when the new systems are released? If so, what would be the optimal year to salvage the equipment? Be specific.

Case Information

As a financial advisor at QDSI, you've been requested to examine two capital investment choices. Before starting your study, you observe that business policy requires a 20% return on all proposed projects. Corporate tax is 24%. The shipping department plans to automate a warehouse using one of two advanced robotics systems. System A costs $2,500,000 to develop. System B development costs $4,000,000. Both systems will be CCA'd at 20%. The company expects Net Working Capital to rise by $50,000 at time zero and $10,000 per year the new system is in use (except at the end of the final year of the project). The increase in Net Working Capital will be recovered at project's completion. If the new robots system is implemented, annual pre-tax savings are predicted as follows:

Pre-tax cost savings

Year	System A	System B
1	1,500,000	2,000,000
2	1,200,000	1,750,000
3	1,000,000	1,500,000
4	950,000	1,250,000
5	900,000	1,100,000

Figure 1 As the capital budgeting analyst, you are required to draft a comprehensive memo, addressed to: The Manager, Shipping Department, answering the following questions:

PROBLEM A: ANSWERED. The calculation of NPV of each alternative using the five steps of capital budgeting and the cost savings are shown in Figure 1 above. For this question, assume that there is no salvage value. At this stage of the analysis, we assume that at the end of the equipments five-year life, it will be scrapped for zero value (answered already below). System A NPV is 389,834.10. System B NPV is 52,725.05.

* Please ignore the extra row at the bottom

The vendors of both systems have indicated that they are working on a new generation of robotics which they expect will totally eliminate the function of the current generation of equipment. If they can do this, they would be willing to repurchase the current systems for the following amounts:

	System A	System B
End of Year 3	500,000	500,000
End of Year 4	300,000	300,000
End of Year 5	0	0

Cost savings for the years the systems are in use will remain, as shown in Figure 1 above and the impact on Net Working Capital will remain as stated up to the point that the equipment is withdrawn from service (with all working capital recovered at the end of the last year of service).

Question B: If the vendors do manage to develop the new generation of equipment, should the shipping department purchase the current generation and then sell it back to the manufacturer when the new systems are released? If so, what would be the optimal year to salvage the equipment? Be specific

Problem B Solution: