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Papillon Systems LLC (Capital Budgeting I) Three years ago Multi Star Inc (MSI) identified and studied a new market frontier. MSI staff established...

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Papillon Systems LLC (Capital Budgeting I) Three years ago Multi Star Inc (MSI) identified and studied a new market frontier. MSI staff established that outsourcing data storage was a market to be exploited and was consistent with the company’s core competencies. The DCF based capital budgeting model used by the company pointed to a favorable net present value. The project also aligned to the corporate strategy and was, at worst, neutral toward PSL’s corporate social responsibility initiatives. (See exhibit one for the original data and the net present value calculations). Papillon Systems LLC (PSL) was incorporated and began operations 25 months ago. The company is 100% owned by MSI. PSL’s sole business is third party business data storage. The company ties into a customer’s client server platform and manages all data retrieval and storage including backup and reconstruction in the event of data loss. PSL management’s opinion is that the business has gone as well as can be expected in regard to profit (see exhibit two) and in regard to customer satisfaction. Marketing and operations have their eye on the CSI (customer satisfaction indexes) and will provide a report to the board of MSI in due course. The board of MSI has asked PSL’s CFO, Mary Davis, to provide a two year post investment appraisal covering their financial investment in PSL. PSL’s financial accounting staff have prepared a summary of financial operations (see exhibit two). As the CFO looks at the summary, she notices that there has been no accounting for inflation. (Inflation has been constant at 3% per year for the last number of years.) She also made a note to consider different options to account for the physical wear and tear of the equipment. In her opinion depreciation should be recorded using a super accelerated rate over two years due to the nature of the assets used (ie: digital technology including software). Ms. Davis has tasked, Sharon Scott, an independent management accountant, to complete the post investment appraisal and prepare the draft report covering financial performance for the board of MSI. REQUIRED: As Sharon Scott, complete the task assigned by Mary Davis.
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Papillon Systems LLC Schedule of the DCF Capital Budgeting Model Exhibit 1 Initial cost of office equipment $ 100,000 NPV analysis Initial cost of hardware $ 500,000 Cost of office equipment (100,000) Initial cost of software $ 300,000 Cost of hardware (500,000) Working capital requirement $ 100,000 Cost of software (300,000) Cost of system maintenance $ 225,000 Working Capital Invested (100,000) Year of system maintenance 2 Life of the investment 5 years PV of two year upgrade (122,449) Operating cash inflow $ 410,000 PV of Net Cash Inflow (after tax) 805,283 Operating cash out flow (including R&M) $ 100,000 PV Working Capital Recaptured 78,353 Salvage value of office equipment $ 36,864 PV of Office equip Salvage 28,884 Salvage value of hardware $ 102,043 PV of Hardware Salvage 79,953 Salvage value of software $ - PV of Software Salvage - Discount rate (WACC) 5.00 % Tax Shield: from Purchase Office Equip 31,238 Tax rate 40 % from Purchase Hardware 167,347 CCA rate on office equipment 20 % from Purchase Software 111,565 CCA rate on hardware 30 % lost from sale of Office equip (9,243) CCA rate on software 100 % lost from sale of Hardware (27,412) lost from sale of Software - 273,494 Net Present Value 143,518
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