Frederick Machine Works (FMW) manufactures machine parts for aircraft auxiliary

Question

Frederick Machine Works (FMW) manufactures machine parts for aircraft auxiliary systems. The company is evaluating the purchase of a new suite of inventory and quality management system software. Specifics regarding the potential purchase: • The SW system will require a payment now of $500,000 • Additional hardware (servers and storage) will cost an additional $150,000. • The SW will be depreciated over four years • The hardware will be depreciated over six years • The SW system will save FCW $100,000 in year 1 and $125,000 per year for the rest of its useful life. • Annual software licensing and maintenance equals 18% of the purchase price of the SW. • Additional system capabilities will generate revenue of $120,000 per year in years 1-4 and $100,000 per year thereafter. • FCW's tax rate is 35% and it uses a cost of capital of 9%.

a) Develop a scheule to compute the annual after-tax cash flows and the NPV and IRR of the project. Is it acceptable?

b) Assume the SW system has an 8-year life. Update your schedule from part a to include the additional two years and compute the NPV and IRR of the project . Is the project acceptable?

c) Comment on the impact of an additional two years useful life on the project assessment. How should management accountants use this type of analysis and information to make better decisions?

Explanation / Answer

Cash Outflow Saving +Depriciation Cash Inflow Net Cash Flow After Tax NPV Year0          -650,000                -650,000        -650,000               -650,000 Year1             -90,000               250,000             120,000                  280,000          182,000                166,972 Year2             -90,000               275,000             120,000                  305,000          198,250                166,863 Year3             -90,000               275,000             120,000                  305,000          198,250                153,085 Year4             -90,000               275,000             120,000                  305,000          198,250                140,445 Year5             -90,000 25000             100,000                    35,000            22,750                  14,786 Year6             -90,000 25000             100,000                    35,000            22,750                  13,565                     5,717 IRR Year0      -650,000 Year1       166,972 Year2       166,863 Year3       153,085 Year4       140,445 Year5         14,786 Year6         13,565 IRR 0.34% Project is acceptable

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