Question

Case Analysis #1

After reviewing the shelf life for your firm’s IT systems, you realize that in the next 5 yrs the firm’s accounting system will have to be replaced. The replacement cost is estimated at $450,000.

In your current budget, you realize you have 310,000 in cash to invest. Right now, you can invest the $310,000 in the bank. This account will pay 4% interest compounded annually. However, a member of your Finance and Accounting department has presented you with an investment opportunity for 310,000 that will generate the following projected after-tax cash flow over the next 5-yrs.

Table 1: After-Tax Cash Flow

Year	Projected Cash Flow
1	84000
2	124000
3	130000
4	124000
5	84000

Based on the information above calculate the following:

Q.1 How much money will be in the bank if you leave it in the Bank for 5 yrs?

Q.2 If you decide to go with the investment opportunity provided by the Finance Manager, what is the nominal payback of the project?

Q.3 Using a present value factor of 6% what is the discounted payback period of the investment opportunity?

Q.4 Calculate the net present value.

Q.5 State which investment opportunity you will accept and why? Be sure to state which investment opportunity, if any, will allow you to afford the replacement of the IT infrastructure which is estimated to cost $450,000.

Answer 1

1-	FV = Pv*(1+r)^n	FV = 310000*(1.04)^5	377162.4
2-
Year	Projected Cash Flow	cumulative cash flow
1	84000	84000
2	124000	208000
3	130000	102000	amount to be recovered in Year 3
4	124000
5	84000
Payback period in Years = year before the final recovery +(amount to be recovered/cash flow of final year of recovery)	2+(102000/130000)	2.78
3-
Year	Projected Cash Flow	present value of cash flow = cash flow/(1+r)^n r= 6%	cumultative present value of cash flow
1	84000	79245.28	79245.28
2	124000	110359.6	189604.8
3	130000	109150.5	298755.3
4	124000	98219.61	11244.65
5	84000	62769.69
Payback period in Years = year before the final recovery +(amount to be recovered/present value of cash flow of final year of recovery)	3+(11244.65/98219.61)	3.11
4-
Year	Projected Cash Flow	present value of cash flow = cash flow/(1+r)^n r= 6%
1	84000	79245.28
2	124000	110359.6
3	130000	109150.5
4	124000	98219.61
5	84000	62769.69
sum of present value of cash flow		459744.6
cash outflow		310000
NPV		149744.6
5-	Investment opportunity with the project would be accepted as present value of cash flow is more than the amount required for replacement cost of 450000 while investment in bank would not be able to provide sufficient funds to replace the system with cost of 450000