Question

Carrington would invest in software and some hardware upgrades that will allow them to better analyze the traffic coming in to their website. Total acquisition costs for this option are estimated to be $400,000. This improved analytics capability is expected to lead to increased revenue of $80,000 in year 1, $120,000 in year 2, $250,000 in year 3, $350,000 in year 4, and $500,000 in year 5. The estimated cost of this obtaining this revenue will be 20% per revenue dollar related to sales staff that will analyze this data and use it to generate new client relationships. Carrington will also incur fixed cost of $10,000 per year related to software updates and hardware maintenance. Carrington will set aside $250,000 in working capital for this project and this capital will be recovered at the end of 5 yrs. The salvage value of the new equipment will be $9,000 at the end of 5 yrs. Carrington uses a 10% hurdle rate to evaluate all projects, Acquisition costs qualify for modified accelerated depreciation of 50,30, and 20% in the first three yrs, Being profitable company income would be taxed at Carrington's tax rate of 30%, and all dollar values referenced in this case are in nominal dollars so for analysis ignore the effect of inflation. This option has five year useful life.

1. Calculate the payback period, internal rate of return, and NPV.

2. The data analytics program pays off a lot faster than expected. Revenue is projected to be $200,000 in yr 1, $250,000 in yr 2, $250,000 in yr 3, $300,000 in yr4, and $300,000 in yr 5.

3. The data analytics program pays off slower than expected. Revenue is projected to be $20,000 in yr 1,$80,000 in yr 2, $200,000 in yr 3, $500,000 in yr 4, and $500,000 in Year 5.

4.A great tax plan. Congress is proposing a new corporate tax plan that reduces the federal tax rate that Carrington pays from 30% to 20%. However, this tax plan would also do away with MACRS and replace it with straight line depreciation for tax purposes ( over 5 yrs).

a. Using the original estimates for your designated option, estimate the effect of this tax plan on NPV.

b. Next, given the uncertainty related to the effect of the proposed tax plan on future business, use a 14% hurdle rate instead of the 10% hurdle rate used before in estimating the effect of the plan (i.e just redo 4A).

5. What are some qualitative concerns related to accepting this designated option. Discuss and list at least 2. Provide why each would be considered an advantage or disadvantage.

Answer 1

		Present Value(PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=discount rate=Hurdle Rate=10%=0.10
		N=Year   of Cash Flow
	N	Year	0	1	2	3	4	5
		INITIAL CASH FLOW
	a	Acquisition Cost	-$400,000
	b	Working Capital	-$250,000
	I=a+b	Total Initial Cash Flow	-$650,000
		ANNUAL CASH FLOW
	c	Increase in Revenue		$80,000	$120,000	$250,000	$350,000	$500,000
	d=c*20%	Variable Costs		$16,000	$24,000	$50,000	$70,000	$100,000
	e	Fixed Costs		$10,000	$10,000	$10,000	$10,000	$10,000
	f=c-d-e	Before Tax Profit		$54,000	$86,000	$190,000	$270,000	$390,000
	g=f*(1-0.3)	Annual After tax Cash Flow(excluding depreciation)		$37,800	$60,200	$133,000	$189,000	$273,000
	h	Depreciation Rate		50%	30%	20%
	i=h*400000	Annual Depreciation		$200,000	$120,000	$80,000
	j=i*30%	Depreciation tax shield		$60,000	$36,000	$24,000
	X=g+j	Operating Cash flow		$97,800	$96,200	$157,000	$189,000	$273,000
	k	Terminal Cash Flow(Release of working capital)						$250,000
	l	After tax Salvage Value =9000*(1-0.3)						$6,300
	T=k+l	Total Terminal Cash Flow in Year5						$256,300
	CF=I+X+T	Net Cash Flow	-$650,000	$97,800	$96,200	$157,000	$189,000	$529,300
		Cumulative Net Cash Flow	-$650,000	-$552,200	-$456,000	-$299,000	-$110,000	$419,300	SUM
	PV=CF/(1.14^N)	Present Valure	-$650,000	$88,909	$79,504	$117,956	$129,090	$328,654	$94,113
	NPV =Sum of PV	Net Present Value(NPV)	$94,113
		Internal Rate of Return (IRR)	14.12%	(Using IRR function of excel over Net Cash Flow)
		Payback Period =Period at which the Cumulative cash flow=0
		Payback Period =4+(110000/529300)=	4.21	Years