As a financial analyst at Delhi Systems you have been asked to evaluate two capital alternatives submitted by the production department of the firm. Before beginning you analysis. As a small business, Delhi pays corporate taxes at the rate of 35%.

The proposed capital project calls for developing new computer software to facilitate partial automation of production in Delhi's plant. Alternative A has initial software development costs estimated at $185,000, while Alternative B would cost $330,000. Software development costs would be capitalized and qualify for a capital cost allowance (CCA) rate of 30%. In addition, IT would hire a software consultant under either alternative to assist in making the decision whether to invest in the project for a fee of $17,000 and this cost could be expensed when it is incurred.

To recover its costs, Delhi's IT department would charge the production department for the use of computer time at the rate of $390 per hour and estimates that it would take 182 hours of computer time per year to run the new software under any alternative. Delhi owns all of its own computers and does not currently operate them at capacity. The Information Technology (IT) plan calls for this excess capacity to continue in the future. For security reasons, it is company policy not to rent excess computing capacity to outside users.

Today, stock in Delphi trades at $55.01 on the TSX. Delhi has a beta of 1.6. The market risk premium historically has been around 4.6% and the estimate of the risk free rate is 2.4%. Delhi's last dividend was $2.04 and some analysts estimate that it will grow at 5% indefinitely.

If the new partial automation of production is put in place, expected savings in production cost (before tax) are projected as follows:

Year Alternative A Alternative B 1 $86,000 $121,000 2 99,000 130,000 3 68,000 98,000 4 57,000 99,000 5 41,000 59,000 1. Calculate the net present value of each of the alternatives. Which would you recommend? 2. The CFO suspects that there is a high risk that new technology will render the production equipment and this automation software obsolete after only three years. Which alternative would you now recommend? {Cost savings for Years 1 to 3 would remain the same.) 3. (3| could use excess resources in its Engineering department to develop a way to eliminate this step of the manufacturing process by the end of year 3. The salvage value of the e uipment (including any CCA and tax impact) would be $50,000 at the end of Year 3, 35,000 at the end of Year 4, and zero after ve years. Should Engineering develop the solution and remove the equipment before the five years are up? Which alternative? When