Company: Roby Decision: Computer system replacement

Original cost of old system: $25,000

Age of old system: 5 years

Current market value of old system:  $5,000

Depreciation: old system over 10 years Depreciation: new system over 5 years

Salvage value: old system's estimated value was $0

Cost of new system: $50,000

Salvage value: estimated value of new system is $1,000

Estimated cost savings with new system: $5,000 per year

Increase in sales with new system: 1% per year based on original total sales

Depreciation: straightline method

Cost of capital: 10%

Tax rate: 40%

Roby’s total sales: $500,000

Operating costs: $350,000

Depreciation is currently $50,000 per year firm-wide

I. net cash outflow (assumed at current time):

steps:

a. book value, old system - market value, old system = operating loss from sale

b. operating loss x tax rate = tax savings from sale

c. cost of new system - (tax savings from sale + market value, old system) = net cash outflow

II. estimated change in cash flows per year if replacement decision is implemented

change in cash flow = ((change sales+change operating costs)-change depreciation))(1-tax rate)+change depreciation

III. present value of benefits = present value of yearly cash flows + present value of estimated salvage, new system

IV. present value of costs = net cash outflow (see I.c)

V. net present value = present value of benefits - present value of costs

VI. decision rule: accept when present value of benefits > present value of costs. Reject when the opposite is true.

A. CONSTRUCT A SPREADSHEET TEMPLATE FOR THE ANALYSIS OF CAPITAL

BUDGETING PROBLEMS.

1. GENERATE A REPORT USING A WORD PROCESSOR WHICH INCLUDES:

A NARRATIVE ABOUT CAPITAL BUDGETING. IN THIS SECTION DISCUSS THE PRINCIPAL CAPITAL BUDGETING TECHNIQUES AND THE DECISION RULE (ACCEPT/REJECT) ASSOCIATED WITH EACH.

A SECOND PART OF THIS SECTION SHOULD INCLUDE A BRIEF SET OF INSTRUCTIONS AS TO HOW TO ACCESS THE SPREADSHEET AND THIS PARTICULAR FILE. A THIRD PART SHOULD DESCRIBE THE THREE MAJOR SECTIONS OF THE SPREADSHEET. THESE ARE IDENTIFIED BELOW.

THE PROBLEM TO BE COMPLETED IN THIS PROJECT IS A REPLACEMENT DECISION - ROBY COMPANY (DETAILS ABOVE).

BEGIN SPREADSHEET WORK HERE!

2. DOCUMENTARY SECTION

a. PROGRAMMER DATA, IE, NAME, ETC. b. SPREADSHEET OVERVIEW (HOW TO USE AND WHAT INFO IT PROVIDES)

3. DATA SECTION (INPUT)

a. COST OF CAPITAL (DESCRIBE IN INTRO.)

b. APPLICABLE TAX RATE

c. ORIGINAL COST OF OLD MACHINE

d. EST SALVAGE VALUE OF MACHINE (OLD & NEW)

e. USEFUL REMANINING LIFE OF MACHINE (OLD & NEW)

f. ANNUAL DEPRECIATION (ASSUME SL) (OLD & NEW)

g. CURRENT BOOK VALUE OF OLD MACHINE

h. CURRENT CASH VALUE OF OLD MACHINE

I. COST OF NEW MACHINE

j. EXPECTED CHANGE IN CASH OPERATING EXPENSES:

1. MAINTENANCE

2. MATERIAL

3. DOWNTIME

k. EXPECTED SALES INCREASE WITH NEW MACHINE

REQUIREMENTS: C, D, E, F, G, I

4. ANALYSIS AND REPORTING SECTION

a. TAX SAVINGS OBTAINED IF OLD MACHINE IS SOLD.

b. NET CASH OUTFLOW IF NEW MACHINE IS PURCHASED

 c. CHANGE IN CASH INFLOW AS A RESULT OF THE REPLACEMENT

d. PRESENT VALUE OF CASH INFLOW STREAM

e. PRESENT VALUE OF ESTIMATED SALVAGE OF NEW MACHINE

f. NET PRESENT VALUE

g. ACCEPT/REJECT DECISION

h. Calculate the internal rate of return. Give the accept/reject decision.

THE SPREADSHEET PRINTOUT SHOULD BE ENTITLED, "CAPITAL BUDGETING: A discounted cash flow analysis"

B. OTHER

1. THE REPORT SHOULD HAVE A COVER SHEET.

2. TURN-IN THE FOLLOWING:

A. TEMPLATE WITH ROBY COMPANY DATA.

B. CELL FORMULAS.

C. TEMPLATE WITH YOUR OWN DATA.