Question
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
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 Delhis 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, Delhis 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%. Delhis 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 | 77,000 | 130,000 |
3 | 68,000 | 98,000 |
4 | 57,000 | 97,000 |
5 | 41,000 | 59,000 |
Calculate NPV ?
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