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Capital Budgeting Exercise
Cassiopeia Consulting currently tracks all direct expenses, including billable hours, for consulting services on a manual basis, employing three employees. TimeWarp Software has developed an automated system for tracking that should cut the processing time significantly. You've gathered the following information to analyze the feasibility of purchasing and implementing this new software. The latest release, WarpPro 3.0, will cost $125,000 plus a one-time licensing fee of $45 per computer that the company plans to expense; this version should last for 4 years after which time a new investment will be needed. Cassiopeia uses straight-line depreciation for capital budgeting purposes. The company has 22 consultants who share 4 administrative assistants; all will need to have the software on their computers. If the company adopts the software, the consultants will need to input much of their expenses and billable hours directly. You anticipate this will take about 3 hours per consultant per month and the average consultant's hourly wage is $75. This will also lower billable hours and the firm's average rate per billable hour is $200. The additional burden on the administrative staff is not expected to affect their productivity. The three employees currently responsible for maintaining expense and hourly records together earn $215,000, including benefits; these positions would be eliminated. The company's estimated weighted average cost of capital is 12.3% and their marginal tax rate is 36%.
1) Calculate the incremental impact on earnings and cash flows.
2) Determine the net present value of the proposal.
3) Make a recommendation to management to either invest in the software or keep the status quo.
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