Management_Accounting_Case_2_Fall_2009 - 10 Economic life...

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M ANAGEMENT 122 F ALL 2009 M ANAGEMENT A CCOUNTING D ANNY S. L ITT CASE ASSIGNMENT 2 Page | 1 You have been asked to help a local company evaluate a major capital expenditure. The company is a new internet company and must buy a large computer system which will generate additional revenue. The company provides you with the following information: Initial cost $35,000,000 Depreciation method Straight-line Salvage value $1,000,000 Residual value $2,000,000 Tax rate 35% Incremental annual revenues $17,850,000 Incremental annual expenses $12,950,000 Working capital required at time of investment $500,000 Working capital as percentage of revenue each year 1.0% Cost of capital
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Unformatted text preview: 10% Economic life 10 years Requirements: a. Write a letter to the president of the company explaining whether the company should acquire the computer system. Utilize both NPV and IRR. Assume that the initial $17,850,000 in annual revenues will grow at a 6% annual rate and that the initial $12,950,000 in annual expenses will grow at a 5% annual rate. The growth starts in year 2 from year 1, i.e. the revenue is year 2 is 18,921,000, etc. Working capital is released at the end of the project. b. Redo this analysis above using sum-of-years digits depreciation method. What happens to the results and would you change your recommendation?...
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