Question
Alpha Star is considering a purchase of sophisticated software for $3m. If implemented, the software will generate earnings before depreciation and tax of $1m a
Alpha Star is considering a purchase of sophisticated software for $3m. If implemented, the software will generate earnings before depreciation and tax of $1m a year for the next three years. The software will also reduce the firms required working capital by $275,000 immediately. At the end of the life of the software, this amount of net working capital will be required again. Alpha Star is expected to use the software for only 3 years. Then it intends to sell it for $500,000. The software, however, can be fully depreciated over three years using a straight line depreciation method. Alpha Stars tax rate is 30%, and its opportunity cost of capital is 9.5%. For a fee of $150,000 (a taxable expense for Alpha Star), you were hired to evaluate the viability of the purchase. While the work is being done now, your consulting fee will be paid in two years. What should be your recommendation - should the software be purchased? Using excel.
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