WWE Company has decided to install a new networked computer system. Initial discussions with the preferred supplier have indicated that the company faces the following two basic options. Option 1: WWE can purchase the system outright for an initial sum of RM45,000. This sum includes a maintenance contract from supplier for the first 12 months. At the end of first year and at the end of each subsequent year, WWE can purchase an annual maintenance contract for RM2,500. At the end of five years, the system will be obsolete and will have a scrap value of RM1,000. Option 2: Alternatively, WWE can lease the system from the computer suppliers. WWE will pay RM12,000 now and a further RM12,000 per annum at the end of each subsequent year. The second lease payment will be due at the end of the first year (to pay for the system through Year 2) and so on. At the end of the fifth year, the system will be scrapped, but its scrap value will go to the suppli er not to WWE. The leasing fee also includes maintenance. (a) Tabulate the company's cash flows of Option 1 and Option 2 over 5 years. (b) Based on your answers in (a), calculate the relevant net present values for each option by discounting the cash flows at 10%. (c) Based on your answers in (b), which option is preferable? Provide your reason of selecting the option. In the reality, do you recommend that the decision be taken simply on the basis of the net present value calculation? Provide your reasoning. (d)
WWE Company has decided to install a new networked computer system. Initial discussions with the preferred supplier have indicated that the company faces the following two basic options. Option 1: WWE can purchase the system outright for an initial sum of RM45,000. This sum includes a maintenance contract from supplier for the first 12 months. At the end of first year and at the end of each subsequent year, WWE can purchase an annual maintenance contract for RM2,500. At the end of five years, the system will be obsolete and will have a scrap value of RM1,000. Option 2: Alternatively, WWE can lease the system from the computer suppliers. WWE will pay RM12,000 now and a further RM12,000 per annum at the end of each subsequent year. The second lease payment will be due at the end of the first year (to pay for the system through Year 2) and so on. At the end of the fifth year, the system will be scrapped, but its scrap value will go to the suppli er not to WWE. The leasing fee also includes maintenance. (a) Tabulate the company's cash flows of Option 1 and Option 2 over 5 years. (b) Based on your answers in (a), calculate the relevant net present values for each option by discounting the cash flows at 10%. (c) Based on your answers in (b), which option is preferable? Provide your reason of selecting the option. In the reality, do you recommend that the decision be taken simply on the basis of the net present value calculation? Provide your reasoning. (d)
Chapter9: Capital Budgeting And Cash Flow Analysis
Section: Chapter Questions
Problem 21P
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Transcribed Image Text:WWE Company has decided to install a new networked computer system. Initial discussions
with the preferred supplier have indicated that the company faces the following two basic
options.
Option 1:
WWE can purchase the system outright for an initial sum of RM45,000. This sum includes a
maintenance contract from supplier for the first 12 months. At the end of first year and at the
end of each subsequent year, WWE can purchase an annual maintenance contract for
RM2,500. At the end of five years, the system will be obsolete and will have a scrap value of|
RM1,000.
Option 2:
Altematively, WWE can lease the system from the computer suppliers. WWE will pay
RM12,000 now and a further RM12,000 per annum at the end of each subsequent year. The
second lease payment will be due at the end of the first year (to pay for the system through
Year 2) and so on. At the end of the fifth year, the system will be scrapped, but its scrap value
will go to the supplier not to WWE. The leasing fee also includes maintenance.
(a)
Tabulate the company's cash flows of Option 1 and Option 2 over 5 years.
(b)
Based on your answers in (a), calculate the relevant net present values for each option
by discounting the cash flows at 10%.
(c)
Based on your answers in (b), which option is preferable? Provide your reason of
selecting the option.
In the reality, do you recommend that the decision be taken simply on the basis of the
net present value calculation? Provide your reasoning.
(d)
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