Gold Corp

As a financial analyst of Gold Corp, you have been asked to evaluate two capital Investment

alternatives submitted by the production department of the firm. Before beginning your

analysis, you note that company policy has set the cost of capital at $18\%$ for all proposed

projects. Gold Corp pays BC small business income tax rate, which is combined federal and

provincial rates of $12\%.$

The proposed Capital project calls for developing new computer software to facilitate partial

automation of production in the company$$s plant. Alternative A has initial software

development costs projected add $$194,000,$ while Alternative B would cost at $$280,000.$

Software development costs would be capitalized and qualify for a capital cost allowance $($CCA$)$

rate of $25\%.$ 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 $$35,000,$ and this cost would

be expensed when is in incurred.

To recover its cost, the company$$s IT department will charge the production department for the

use of the computer time at the rate of a $$450$ per hour and estimate that it would take $180$

hours to of computer time per year to run the new software under either alternative.

The company owns all its 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.

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

$1$ $$80,000$ $$120,000$

$2$ $$80,000$ $$130,000$

$3$ $$60,000$ $$105,000$

$4$ $$50,000$ $$90,000$

$5$ $$30,000$ $$50,000$

As the capital budgeting analyst, you are required to answer the following in your memo to the

production department

a$)$ calculate the net present value of each of the alternatives. Which option would you

recommend, and why? Show you calculations.

b$)$ The CFO believes that it is a high risk the new automation software will be obsolete after

three years which alternative would you now recommend? $($Cost saving for Years $1$ to $3$

would remain the same.$)$

c$)$ The company has an opportunity to utilize excess resources in its engineering

department, and it will then eliminate the above production step of the manufacturing

process by the end of Year $3.$ The salvage value of all production equipment $($including

any CCA and tax impact$)$ would be $$65,000$ at the end of Year $3.$ On the other hand,

$$50,000$ at the end of Year $4,$ and zero after five years. Should the CFO request

engineering department to develop this solution, so the process will be eliminated?

Provide your rationales? Explain to the CFO which alternative $($A$/$B$)$ he$/$she should select

and Why?