Reference no: EM13597254

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: $1,000,000

• Depreciation method for requirement A (below): Straight-line
• Depreciation method for requirement B (below): Sum-of-Years Digits

• Salvage value: $0
• Residual value (Value at end of project): $25,000
• Tax rate: 35%
• Incremental annual revenues in year 1: $227,000
• Incremental annual expenses in year 1: $77,500

• Additional working capital required now and released at end of project: $10,000

• Cost of capital: 10%
• Economic life: 10 years

Requirements (show all work):

A. Write a letter to the president of the company explaining whether the company should acquire the computer system. Show your complete analysis. Utilize both NPV and IRR. Assume that the initial $227,000 in annual revenues will grow at a 6% annual rate each year ($240,620 in year 2, etc.) and that the initial $77,500 in annual expenses will grow at a 5% annual rate each year ($81,375 in year 2, etc.).

B. Redo this analysis above using sum-of-years digits depreciation method. What happens to the results and would you change your recommendation?