EYK 12-1 Business Decision Case New Haven Corporation recently identified an investment opportunity involving the purchase of a patent that will permit the company to modify its line of CD recorders. The patents purchase price is $750,000 and the legal protection it provides will last for five more years, there is no salvage value. However, after preparing the capital expenditure analysis below, New Havens treasurer has recommended to the companys capital budgeting committee that the investment be rejected. Brad Decker, chairperson of the capital budgeting committee, finds it difficult to accept the treasurers analysis because he feels intuitively that the investment is attractive. For this reason, he has retained you to review the treasurers analysis and recommendations. You are provided with the following data and summary of the treasurers analysis: 1. Required investment: $750,000 cash for the patent to be amortized on a straight-line basis, five year useful life, with a zero salvage value 2. Projected cash revenue and operating expenses: 3. Source of capital: New Haven plans to raise 10% of the needed capital by issuing bonds, 30% by issuing stock, and the balance from retained earnings. For these sources, the capital cost rates are 8%, 9% and 10% respectively. New Haven has a policy of seeking a return equal to the weighted average cost of capital plus 1.5 percentage points as a buffer margin for the uncertainties involved. 4. Income taxes: New Haven has an overall income tax rate of 30% 5. Treasurers analysis (students do not have to verify these numbers): Treasurers Recommendation: Reject investment because of insufficient net present value Required: a. Review the treasurers analysis, identify any questionable aspects and briefly comment on the apparent effect of each such item on the treasurers analysis Year Cas h Revenue Cas h Expens es 1 620,000 240,000 2 560,000 200,000 3 400,000 170,000 4 250,000 80,000 5 200,000 50,000 2,030,000 740,000 Average Cos t of Capi tal (8% + 9% + 10%) / 3 = 9% Total cas h revenue 2,030,000$ Total cas h expens es 740,000$ Total amorti zati on 750,000$ Total Operati ng Expens es 1,490,000$ Proj ected Net Income over fi ve years 540,000$ Average annual i ncome 108,000$ Pres ent val ue of future returns 443,420$ Requi red i nves tment 750,000$ Negati ve Net Pres ent Val ue (276,580)$

b. Prepare your own analysis of the investment, including a calculation of the proper cost of capital and hurdle rates, a net present value analysis of the project, and a brief recommendation to Decker regarding the investment (round amounts to the nearest dollar) 1. Because of his concern for the uncertainties of the CD recorder business, Decker also has asked you to provide analysis supporting whether or not your recommendation would change if estimates of projected cash revenue were reduced by 10%