Question

An IT company is considering implementing an automated system to save on software testing labor costs manually. The entire system will be financed through a bank loan, to be repaid in 3 equal annual installments. The financial data relevant to this project is given in the table below:. COSTS AMOUNT System Hardware Purchase Cost $325,000 Operating Software Fee (at n=0) $25,000 Bank Loan Interest rate (compounded annually) 10% System Life 3 years Salvage Value (at n=3) $100,000 Capital Cost Allowance (50% rule applicable) CCA(45%) Annual Savings in Manual Testing Labor Costs $150,000 Annual O&M expenses $20,000 Working Capital (invested at n=0 and fully recovered at n=3) $15,000 Corporate Income Tax Rate 35% MARR 12% Create and submit a cash flow statement for the project using Excel, to evaluate the economic feasibility of the project. Based on your cash flow analysis, write a statement in your excel file to confirm if you recommend implementing the project? Why?

Answer 1

Economic Feasibility of the Project
Cash Flow Statement
Particulars	Year 0	Year 1	Year 2	Year 3
Loan for Automated System	($3,25,000)	$0	$0	$0
Operating Software Fee	($25,000)	$0	$0	$0
Repayment of Loan	$0	($1,08,333)	($1,08,333)	($1,08,333)
Interest payment on Loan	$0	($32,500)	($21,667)	($10,833)
Savings in Tax due to Depreciation	$0	$26,250	$26,250	$26,250
Savings in Annual Labour Cost	$0	$1,50,000	$1,50,000	$1,50,000
Annual o&M Expenses	$0	($20,000)	($20,000)	($20,000)
Working Capital	$0	($15,000)	($10,000)	($5,000)
Savings in Tax due CCA	$0	$25,594	$39,670	$21,819
Salvage Value of the asset	$0	$0	$0	$1,00,000
Net (Outflow) / Inflow	($3,50,000)	$26,011	$55,920	$1,53,903
MARR @ 12%
NPV	($1,54,153)	Outflow
Working Notes
Repayment Schedule	Year 0	Year 1	Year 2	Year 3
	$3,25,000	$0	$0	$0
	$0	$1,08,333	$0	$0
	$0	$0	$1,08,333	$0
	$0	$0	$0	$1,08,333
Interest on Loan	$0	$32,500	$0	$0
	$0	$0	$21,667	$0
	$0	$0	$0	$10,833
Depreciation
Purchase Price	$3,25,000
Salvage Value	$1,00,000
Life	3 years
Depreciation	$75,000
Tax Rate	35%
Savings in Tax due to Depreciation	$26,250
Capital Cost Allowance CCA	Year 1	Year 2	Year 3
CC @ 45% (50% allowed)	$73,125	$1,13,344	$62,339
Corporate Tax Rate @ 35%	$25,594	$39,670	$21,819

Based on the above NPV and Cash Flow Calculations, I would not recommed in implementing the automated labour system as the NPV shows a negative outflow of $154,153. As the NPV is negative, we would not recommed implementing the project.