Question

IT软件项目

As a senior analyst for the company you have been asked to evaluate a new IT software project. The company has just paid a consulting firm $100,000 for a test marketing analysis. After looking at the project plan, you anticipate that the project will need to acquire computer hardware for a cost of $450,000. The Australian Taxation Office rules allow an effective life for the computer hardware of five years. The equipment can be depreciated on a straight-line (prime cost) basis and there is no expected salvage value after the five years.

Your company does not have any available space where the project can be located for five years and you anticipate a new office will cost $65,000 to rent for the first year (same cost for the remaining years). You expect that the project will need to hire 3 new software specialists at $50,000 (each specialist) per year (start in year 1) for the full five years to work on the software (same cost for the remaining years).

The project will use a van currently owned by the company. Although the van is not currently being used by the company, it can be rented out for $15,000 per year for five years. The book value of the van is $20,000. The van is being depreciated straight-line (with five years remaining for depreciation) and is expected to be worthless after the five years.

Expected annual marketing and selling costs will be incurred during the life of the project (5 years), with the first year expecting to be $250,000. The produced software is expected to sell at $85 per unit while the cost to produce each unit is $40. You expect that 10,000 units will be sold in the first year and the number of units sold will increase by 25% a year for the remaining four years. The project will need working capital of $50 000 to commence the business (in year 0) and the investment in working capital is to be completely recovered by the end of the project’s life (in year 5). The company tax rate is 30%, and the discount rate is 10.5%.

Based on the information presented above, answer the following questions (1) – (3).

1. In evaluating the new IT software project, are the cost of $100,000 spent on marketing analysis? Explain your answer.

2. Calculate the incremental free cash flow during the project’s life (starting from year 0 to year 5). Show workings.

3. Calculate the NPV, payback period and IRR of the project. Should the project be accepted? Show workings and explain your answer(s).

Answer 1

1. The cost of $100,000 spent on marketing analysis has already been occured. It is sunk cost. So, it can't be recovered. There is no need to reflect sunk cost in the incremental cash flows. These costs are not part of the future incremental cash flow associated with the acceptance of the project.

2.Calculation of incremental cash flows:

	Year0	Year1	Year2	Year3	Year4	Year5
Cost of computer hardware	(4,50,000)
Savings of tax on depreciation(450000/5)		27,000	27,000	27,000	27,000	27,000
Office rent		(65000)	(65,000)	(65,000)	(65,000)	(65,000)
Specialist cost		(1,50,000)	(1,50,000)	(1,50,000)	(1,50,000)	(1,50,000)
Opportunity cost of van which can be rented		(15,000)	(15,000)	(15,000)	(15,000)	(15,000)
Cost of van	(20,000)
Savings of tax on depreciation (20,000/5)		1,200	1,200	1,200	1,200	1,200
Annual Marketing and selling cost		(2,50,000)	(2,50,000)	(2,50,000)	(2,50,000)	(2,50,000)
Net income on sale of product $(85-40)=45 Units(25% increase every year) year1: 10000 Year2: 12500 Year3: 15625 Year4: 19531 Year5: 24414		450000	562500	703125	878895	1098630
Working captal	(50,000)					50,000
Total	(5,20,000)	1,800	1,10,700	2,51,325	4,27,095	6,96,830
PVF @10.5%	1	0.905	0.819	0.741	0.671	0.607
	(5,20,000)	1,629	90663.3	186231.82	286580.75	422975.81

INCREMENTAL CASH FLOWS= Cash Inflows- Cash Outflows

=14,87,750-5,20,000

=$9,67,750

Annual Marketing and selling cost is assumed to be constant for all years as no fixed percentage is given in question.

3. Calculation of NPV= PV of cash inflows- PV of cash outflows

=988080.68-520000

=$4,68,080.68

Payback Period= Amount of Investment/Annual cash flow

=1487750/520000

=2.86 Years

4. Calculation of IRR

Point where NPV should be zero+

0=(520000)/(1+IRR)⁰ +1800/(1+IRR)¹+ 110700(1+IRR)²+ 251325/(1+IRR)³+ 427095/(1+IRR)⁴+ 696830/(1+IRR)⁵

IRR= ra+ NPVa*(rb-ra)/NPVa-NPVb

ra= Lower discount rate assumed

rb= Higher discount rate assumed

Na= NPV at ra

Nb= NPV at rb

ra=10% , rb= 15%

=NPV (ra = 10%) =485560

=NPV(rb= 15%) = 320997

=10+485560(15-10)/(485560-320997)

24.75%

Conclusion: Project should be accepted as there is positive NPV, IRR is higher than discount rate. Also payback back period is shorter than tenure of project.