NOT GRADED

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 patent's purchase is $720,000 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 haven's treasurer has recommended to the company's capital budgeting committee that the investment rejected. Brad Decker, chairperson of the capital budgeting committee finds it difficult to accept the treasurer's analysis because he "feels intuitively" that the investment is attractive. For this reason, he has retained you to review the treasurer's analysis and recommendation. You are provided with the following data and summary of the treasurer's analysis: 1. Require Investment: $720,000 cash for the patent to be amortized on straight line basis, five-year useful life with zero salvage value.

2. Projected cash revenue:

year	cash revenue	Cash exepense
1	$620,000	$240,00
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

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 the 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 2.5 percentage points as the "buffer margin" for the uncertainties involved.

4. Income taxes: New Haven has an overall income tax rate of 30%.

5. Treasurers analysis:

Avg cost of capital (8%+9%+10%)/3 = 9%

Total Cash Revenue.......................................................$2,030,000

Total Cash Expense..............$740,000 Total Amortization..................$720,000 Total Operating Expense.................................................$1,460,000 Projected Net income 5 years.........................................$570,000

Average Annual Income..................................................$114,000 Present Value of future returns........................................$443,420 Required investment.......................................................$720,000

Negative net present value...............................................$(276,580)

Recommendation: Reject investment because of insufficient net present value.

REQUIRED (NOT GRADED) PLEASE USE A, B, C Format

A. Review the treasurer's analysis, indentifying any questionable aspects and briefly comment on the apparent effect of each such item on the treasurer's analysis. (Please be specific and explain)

B. Prepare your own analysis of the investment, including a calculation of the proper cost of the capital and hurdle rates, a net presetn value analysis of the project, and a brief recommendation to Decker regarding the investment. (Round Amounts the nearest dollar)

C. Because of this concern for the uncertainties of the CD recorder business, Decker also has asked you to provide analyses supporting whether or not your recommendation would change: 1. If estimates of projected cash revenue were reduced by 10% 2. if the "buffer margin" were tripled from 2.5% to 7.5%