You ask your recent MBA hire to evaluate the attractiveness of an investment in a piece of
Question:
You ask your recent MBA hire to evaluate the attractiveness of an investment in a piece of computer equipment you've been interested in. He gives you the following report. (Assume that he at least collected all the figures correctly.) The equipment cost $150,000 and will be straight-line depreciated over 5 years. It will replace an existing system -- that would otherwise be used for the five years -- which has been fully depreciated and could be sold for $3,000. It requires the use of software, which the firm has recently purchased for $20,000. The equipment will improve efficiency, which will allow you to cut costs by $60,000/year. The maintenance of the product requires the time of 1/10th of an employee with salary $30,000 and who generates $50,000 of profits to the firm. An additional $5,000 must be reserved for operations. You know that you can sell this product after 5 years for $50,000. Your firm is taxed at 30%. Last year, your firm had a price increase of 15%. You also know that firms who are only in this no-growth business are trading at a P-E multiple of 10. You receive the following analysis with a recommendation against the investment:
| 0 | 1 | 2 | 3 | 4 | 5 |
Cost Savings |
| 60 | 60 | 60 | 60 | 60 |
Maintenance |
| -3 | -3 | -3 | -3 | -3 |
Buy Eqpt | -150 |
|
|
|
| 50 |
Sell Old | 3 |
|
|
|
|
|
Oppurtunity cost of 150K at 15% |
| -22 | -22 | -22 | -22 | -22 |
Depreciation |
| -20 | -20 | -20 | -20 | -20 |
Software | -20 |
|
|
|
|
|
EBIT | -167 | 15 | 15 | 15 | 15 | 65 |
Taxes |
| 4.5 | 4.5 | 4.5 | 4.5 | 19.5 |
Net CF | -167 | 11 | 11 | 11 | 11 | 46 |
IRR<0<Required 15% return. Is this analysis correct? If not, where did your MBA go wrong? Redo the analysis to determine whether you should invest in the new equipment.
Managerial accounting
ISBN: b010ikdqzm
10th Edition
Authors: Carl S. Warren, James M. Reeve, Jonathan E. Duchac