As a financial analyst at Busy Blocks Concrete Ltd. (BBCL), you have been asked to evaluate two

capital investment alternatives submitted by the Manufacturing Department. Before beginning

your analysis, you note that company policy has set the minimum desired rate of return at 15% for

all proposed projects. You also learn that the corporate tax rate is 26%.

The proposed capital project calls for the Manufacturing Department to fully automate a

production facility using one of two different advanced robotics systems. System A will incur

development costs of $130,500. System B will cost $450,000 to develop. Both systems will be

capitalized and amortized using a CCA rate of 20%. In addition, the firm believes that Net

Working Capital will rise by $75,000 at time zero and then by an additional $11,000 at the end of

each year for each year that the new system is operating (except at the end of the final year of the

project). This applies to both alternatives. However, all of the increase in Net Working Capital will

be recovered at the end of the project.

The Manufacturing Department intends to hire an outside CPA at a cost of $35,000 to advise the

company on which of the two alternatives would be most effective, or if neither alternative is

financially attractive. The amount paid to the CPA will be expensed at the time it is incurred.

BBCL owns all of its computer equipment, which has significant spare capacity. It is company

policy notto rent spare computer capacity to outside users due to security concerns. As such, the

company is anticipating maintaining spare computer capacity into the future. To recover a portion

of the development cost, the Manufacturing Department intends to charge BBCLs Purchasing

Department for the use of computer time at the rate of $65 per hour for 90 hours per year for

each year of the project. The amount charged will remain constant regardless of the capital

investment alternative selected.

If the new automated robotics system is put into use, the pre-tax cost savings each year are

estimated as follows:

Table 1

Year System A System B

1 $150,000 $450,000

2 $60,000 $200,000

3 $35,000 $198,000

4 $30,000 $25,000

5 $200 $25,000

As the financial analyst, you are required to draft a comprehensive memo, addressed to:

The Manager, Manufacturing Department, answering the following questions:

1. How should the $35,000 payment to the CPA be handled in the capital budgeting analysis?

Why? Be specific.

2. How should the $65 per hour charge for computer time charged by the Manufacturing

Department to the Purchasing Department be included in the capital budgeting analysis?

Why? Be specific.

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3. What discount rate should you use in the capital budgeting analysis? Why?

4. Calculate the NPV of each alternative using the six steps of capital budgeting and the cost

savings shown in Table 1 above. For Question #4, assume that there is no salvage value.

At this stage of the analysis, we are assuming that at the end of the equipments 5-year life,

it will be scrapped for zero value.

5. In Question #5, the CFO is concerned that a change in technology might make the new

system obsolete after 3 years. If this occurs and you only obtain 3 years of cost savings (as

per Table 1 above) and no salvage value, which alternative (if any), would you now

recommend?

6. In Question #6, 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 are able to do this, they would be willing to repurchase

the current systems for the following amounts:

System A System B

End of Year 3 $80,000 $45,000

End of Year 4 $60,000 $15,000

End of Year 5 $40,000 $5,000

Cost savings for the years the systems are in use will remain as shown in Table 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). If the vendors do manage to develop the new generation of

equipment, should the shipping department purchase the current generation and then sell

back to the manufacturer when the new systems are released? If so, what would be the

optimal year to salvage the equipment? Be specific.