Rachel Rodriguez was very inquisitive growing up. Rachel, like most children in

developed economies, enjoyed playing on the computer. Her curiosity went further than

normal. Rachel was in the habit of cracking open her laptop, computer and cellphone to

see how the electronics were connected and to understand how the devices worked.

Initially Rachel's parents were not amused. Eventually they encouraged her interest in

electronics.

Years later Rachel enrolled in a computer class in high school and became certified in

Microsoft Office. During high school summers Rachel worked for a local computer store.

When business was slow the owner would teach her how computers worked. Rachel went

on to major in computer science at the University of Maryland. Her long-term desire was

to own her own computer consulting business, helping clients set up their computer

networks and servicing all their information technology ("IT") needs.

After earning B.S. in Computer Science from the University of Maryland, Rachel got a

job at a local bank as an IT help desk technician. After five years at bank, Rachel started

her own computer consulting company. While Rachel's computer consulting had been

successful, many of the company's clients wanted to purchase the computer equipment

from the business as well. Recently Rachel's Enterprise Solutions Inc ("ESI") has begun

offering leased computer equipment as well as consulting services. ESI's target market

was small businesses.

After graduating from Regent University with a MBA degree you took a job as a finance

analyst at ESI. Rachel believes that you have enough experience to help with the capital

budgeting decisions now facing ESI.

Rachel's ESI had the following balance sheet and income statement for the year ending

December 31, 202x.

Rachel's Enterprises Solutions Incorporated

Balance Sheet

As at December 31, 202x

ASSETS LIABILITIES

Cash $ 37,000 Accounts Payable $ 40,000

Marketable Securities 10,000 Wages Payable 10,800

Accounts Receivable 63,000 Taxes Payable 7,200Uncollectible Accounts -2,000 Short-Term Note Payable 30,000

Inventory 74,000 Interest Payable 2000

Supplies 4,000 Unearned Revenue 20,000

Prepaid Insurance 7,500 Unearned Consulting Rev. 5,000

Total Current Assets $193,500 Total Current Liabilities $ 115,000

Land $111,500 Long-Term Notes Payable $ 50,000

Equipment 217,000 Bonds Payable 100,000

Accumulated Depreciation -97,000 Mortgage Payable 350,000

Building 590,000 Total Long-Term Liabilities $500,000

Accumulated Depreciation -110,000

Intangible Assets 60,000 STOCKHOLDER EQUITY

Total Long-Term Assets $771,150 Capital Stock $100,000

Paid in Capital 140,000

Retained Earnings 110,000

Total Stockholders Equity $350,000

Total Assets $965,000 Total Liabilities & Equity $965,000

Rachel's Enterprises Solutions Incorporated

Income Statement and Segment EBITDA

For the 12 Months Ending December 31, 202x

Equipment Sales Revenue 1,333,440

Consulting Service Revenue (Online Help) 450,000

Total Revenue 1,783,440

Cost of Goods Sold 934,450

Selling, General & Administrative 33,820

Depreciation & Amortization 58,665

Earnings Before Interest and Tax (EBIT) 756,505

Interest 35,576Earnings Before Tax (EBT) 720,929

Tax 152,686

Net Income 568,243

Shares Outstanding 14,000

Earnings Per Share 40.59

Equipment sales EBITDA 667,720

Consulting Online Help EBITDA 147,450

Total EBITDA 815,170

Rachel is putting together a growth plan for ESI. She is evaluating whether to

substantially invest in company owned equipment, and whether to outsource her online

services personnel to a call center in New Dehli, India. Rachel has asked for your

analysis of the following two decisions facing ESI:

1. Equipment Purchase - ESI may decide to purchase outright additional computer

equipment. ESI can continue to lease equipment from hardware vendors. Such a

status quo decision comes with known margins and profitability metrics. The

status quo is embodied in the income statement and balance sheet reported in

202x data given above. Rachel believes adding owned equipment to its existing

leasing business will enable ESI to more fully utilize their fixed assets, grow

faster and provide more customized services to a larger group of future clients.

Rachel is proposing to purchase $500,000 of additional IT equipment. The

equipment would be installed and prepared for use in the current year. When fully

utilized the equipment would generate asset turnover of approximately 2x gross

investment. It would likely take four years to reach full utilization. The useful life

of equipment for accounting and tax purposes is 10 years. However, due to rapid

life cycles in enterprise technology, after six years Rachel expects to sell the

equipment for 10% of initial cost. The EBITDA (operating income plus

depreciation and amortization) margin of business done with owned equipment is

1.1x the margin of business done with leased equipment.2. Outsourcing online consultants - Rachel may move her entire online service team

to India. As she has tried to re-sign existing clients and win new business Rachel

has been feeling pricing and margin pressure. For the time being Rachel has only

re-signed or sought new business that matches her current margin profile. Rachel

expects to be able to maintain the status quo in the online services business for

several more years. However, for the most part Rachel's regional and national

competitors have outsourced online support to low-cost countries. ESI's higher

cost structure limits the future growth of ESI services. ESI's five full time online

consultants each make $60,000 per year. The online segment cost of goods sold is

a little more than the $300,000 paid to the consultants in the most recent year.

Consulting EBITDA is approximately $147,450. If ESI does not outsource its

consultants it is estimated consultant margin dollars will remain about flat for the

next several years. For comparison, online consultants in India make

approximately $30,000 per year, growing at 10% per year. In the first year after

moving to India Rachel expects consulting EBITDA margins dollars to be the

same as in the US. However, in years 2 through 10 consulting revenue should

grow by 20% per year, while the increase labor cost and productivity gains of

India employees should just about offset. This means ESI could maintain its

current consulting EBITDA margin on a growing revenue base. Uncertainty in

technology life cycles means Rachel doesn't think it is reasonable to plan an

online services business beyond 10 years into the future. To make the move to

India, ESI would pay the cost of a fairly generous severance. It is expected US

employees would receive a package valued at 50% of annual compensation. ESI

would sell five U.S. based computer terminals and desks for $8000. The setup

costs in India, including new office space, equipment and telecom infrastructure is

$100,000. The setup costs will be amortized over 10 years. For conservatism,

after 10 years ESI assumes zero recovery on any office furniture, and no future

lease liabilities.

Additional Capital Budgeting Assumptions:

Marginal and average corporate tax rate of 21%.

Pretax cost of bank borrowing is 5%.

As a private firm ESI has an internally defined required return on equity of 10%.

ESI's banks charge a 2% premium for international investments. The required equity

return should also be charged a risk premium over domestic investments.

ESI expects to maintain the ratio of equity and long-term liabilities shown in the 202x

balance sheet.

The reinvestment rate earned on idle cash is 3%.Required

1. Calculate the capital budgeting decision metrics for the proposed expansion in

ESI owned computer equipment. Calculate each of NPV, IRR, MIRR, Payback

and Profitability Index. Show all calculations including initial outlay, annual

differential cash flows, terminal value, and weighted average cost of capital. (30

points).

2. In addition to the capital budgeting calculations, discuss at least three important

qualitative issues associated with the proposed purchase of additional computer

equipment. (10 points).

3. Calculate the capital budgeting decision metrics for the proposed outsourcing of

ESI's online help desk to New Dehli, India. Calculate each of NPV, IRR, MIRR,

Payback and Profitability Index. (30 points).

4. Discuss the challenging issues Rachel may create for ESI by outsourcing online

help services to an overseas location such as India. In the discussion include any

biblical moral principles that apply to ESI's decision. (10 points).

5. Make a definitive recommendation to Rachel. Should ESI make one, both or

neither investment? Base your recommendation on your calculations and

qualitative analysis. Include in your recommendation the two or three most

critical elements of your qualitative reasoning. ESI's future, and your career, are

in part dependent on the quality of your advice. (10 points).