Kelly Bucek is manager of the customer service division of a retail computer store, Quik Computers. Kelly would like to buy computer diagnostic equipment that costs $10,000. The equipment will last five years. Kelly estimates that the incremental operating cash savings from using the equipment will be $3,000 annually, measured at current prices. For income tax purposes, she will depreciate the equipment using the straight-line method, ignoring the half-year convention. Kelly requires a 10% real rate of return. The annual inflation rate is 5%, and the marginal income tax rate is 30%.
Required Information Analysis
The following questions will help you analyze the information for this problem. Do not turn in your answers to these questions unless your professor asks you to do so.
A. Create a spreadsheet schedule showing the net present value calculations for the equipment.
B. Identify factors in your calculations that are uncertain and explain why they are uncertain.
C. Explain how changes in technology might influence the risk involved in this project.
D. Decide which of the factors you identified in Part B would likely have a significant impact on the net present value calculation. Use your spreadsheet to vary each of these factors, performing sensitivity analyses.
E. Use the quantitative results and your judgment to interpret your sensitivity analyses. Which factors seem to have the largest and smallest effects on the NPV results?
F. Describe the pros and cons of investing in the equipment.