Part I -As a financial analyst at Minor International you have been asked to evaluate two capital investment alternatives submitted by the production department of the firm. Before beginning your analysis, you note that company policy has set the set cost of capital at 15 % for all proposed projects. As a small business, MI pays corporate taxes at the rate of 35%. The proposed capital project calls for developing new computer software to facilitate partial automation of production in MI’s plant. Alternative A has initial software development costs projected at $185000, while Alternative B would cost $320000. Soft ware development costs would be capitalized and qualify for a capital coast allowance (CCA) rate of 30 percent. In addition, IT would hire a software consultant under either alternative to assist in making the decision whether to invest in the project for a fee of $16000 and this cost would be expenses when it is incurred. To recover its costs, MI’s IT department would charge the production department for the use of computer time at the rate of $375 per hour and estimates that it would take 182 hours of computer time per year to run the new software under either alternative. MI owns all its computers and does not currently operate them at capacity. The information technology plan calls for this excess capacity to continue in the future. for security reasons, it is company policy not to rent excess computing capacity to outside users. If the new partial automation of production is put in place, expected savings in production cost (before tax) are projected as follows:Year Alternative A Alternative B1 $82,000 $112,0002 82,000 124,0003 64,000 101,0004 53,000 93,0005 37,000 56,000As the capital budgeting analyst, you are required to answer the following in your memo to the production department. a) Calculate the net present value of each of the alternatives. Which would you recommend? B) The CFO suspects that there is a high risk that new technology will render the production equipment and this automation software obsolete after only three years. Which alternative would you now recommend?(Cost savings for years 1 to 3 would remain the same.) C) MI could use excess resources in its engineering department to develop a way to eliminate this step of the manufacturing process by the end of year 3. The salvage value of the equipment( including any CCA and tax impact) would be $50,000 at the end of year 3, $35,000 at the end of year 4, and zero after five years. Should engineering develop the solution and remove the equipment before the five years are up? Which alternative? When?PART 2)As a financial analyst at Glencolin International (GI) you have been asked to revisit youranalysis of the two capital investment alternatives submitted by the production departmentof the firm. (Detailed discussion of these alternatives is in the Mini Case is attached.) The CFO is concerned that the analysis to date has not really addressed therisk in this project. Your task is to employ scenario and sensitivity analysis to explore howyour original recommendation might change when subjected to a number of “what-ifs.”In your discussions with the CFO, the CIO and the head of the production department, youhave pinpointed two key inputs to the capital budgeting decision: initial softwaredevelopment costs and expected savings in production costs (before tax). By properlydesigning the contract for software development, you are confident that initial softwarecosts for each alternative can be kept in a range of plus or minus 15 percent of the originalestimates. Savings in production costs are less certain because the software will involvenew technology that has not been implemented before. An appropriate range for these costsis plus or minus 40 percent of the original estimates.As the capital budgeting analyst, you are required to answer the following in your memo tothe CFO:1. Conduct sensitivity analysis to determine which of the two inputs has a greater inputon the choice between the two projects.2. Conduct scenario analysis to assess the risks of each alternative in turn. What areyour conclusions?3. Explain what your sensitivity and scenario analyses tell you about your originalrecommendations.
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