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NPV Analysis for Equal Experts' Software Investment

Equal Experts is considering diversifying into software and estimates revenues of $127.2 million annually over 4 years from three software products and services. Setup costs are $200 million with half payable immediately and half in a year. Annual working capital of $45 million is also required for 4 years. Engineers will cost $35 million annually to develop the software. To evaluate the project, Equal Experts analyzed similar company Aera Technologies and must now determine if entering the software industry provides positive net present value using a discounted cash flow analysis.

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85 views1 page

NPV Analysis for Equal Experts' Software Investment

Equal Experts is considering diversifying into software and estimates revenues of $127.2 million annually over 4 years from three software products and services. Setup costs are $200 million with half payable immediately and half in a year. Annual working capital of $45 million is also required for 4 years. Engineers will cost $35 million annually to develop the software. To evaluate the project, Equal Experts analyzed similar company Aera Technologies and must now determine if entering the software industry provides positive net present value using a discounted cash flow analysis.

Uploaded by

darshanshah86
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Assignment Question

Equal Experts is a manufacturing company which is considering diversifying its activities with a start-up in software industry. Equal Experts has just spent $150,000 on
market research in software industry. The software project will have revenue from three activities:

1. Software A which will be 100% inhouse and generate revenue of 45.2 million $ per annum
2. Maintenance and upgradation services related to software A also provided by Equal experts to its buyers generating revenue of 40 million dollars per annum
3. Software B, some part of which is outsourced and total revenue generated from software B is expected to be 42 million dollars. But the outsourced company which
helps in partial development of software will share 30% of the revenue.

All costs and receipts (excluding maintenance and setup costs and the realisable value) are shown at current prices; the company expects all costs and receipts to rise by 5%
per year from current values. The software company setup would cost a total of $200 million and to train engineers and start the actual operations would take up one year.
Revenues will be generated only from the second year. The company would be operating for 4 whole years. Half of the setup cost of $200 million would be payable
immediately, and half in one year’s time. In addition, working capital of $45 million per annum will be required from the end of year one up to end of year four, recovery of
the same will be in the fifth year. Maintenance costs (excluding engineer’s salaries) are expected to be $12 million in the first year of operation, increasing by $4 million per
year thereafter. Annual insurance costs are $1 million. The company requires 350 engineers costing a total salary of $35 million per annum (at current prices). As Equal
Experts has no previous experience in software industry, it has investigated the current risk and financial structure of the closest domestic software company, Aera
Technologies. Details are summarised below.

Aera Technologies, summarised statement of financial position $ (million)


Non‐current assets (net) = $1,500
Current assets = $500
$1 ordinary shares = $500
Reserves = $400
Medium‐ and long‐term debt = $600
Current liabilities = $500

Other information:
(i) Depreciation is 25% on WDV. The realisable value of non‐current assets is expected to be between $60 million and $70 million after four years of operations.
(ii) Equal Experts’ market weighted gearing is estimated to be 65% equity, 35% debt. Corporate tax is at a rate of 30%.
(iii) The current share price of Aera Technologies is 345 cents & Aera Technologies’ equity beta is 1.45.
(iv) Aera Technologies’ medium‐ and long‐term debt comprises long‐term bonds with a par value of $100 and current market price of $93.
(v) The average stock market return is 10% and the risk‐free rate 3.5%.
(vi) Equal Experts has access to loan at 8% fixed rate

Required:
Prepare a report analysing whether or not Equal Experts should undertake the investment in the software industry using the “NET PRESENT VALUE” method.
State clearly any assumptions that you make. All workings to be made in Spreadsheet (e.g. MS Excel) and working notes should form part of the answer.

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