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General Phone Apps (GPA) is evaluating a proposal to internally develop a softwa

ID: 1091500 • Letter: G

Question

General Phone Apps (GPA) is evaluating a proposal to internally develop a software capability that is intended to enhance their application (app) development process by automating testing and simplifying product conversion among different operating systems. Since it will be cloud based, it also will facilitate group development projects and enable employees to more easily work from different locations. This is not a product to be sold, but rather it will assist internal development of their app software, so it is depreciable. The development and conversion process is estimated to take one year in year 0, and cost $1,000,000. This investment includes all programming training, loading of existing products and testing the resulting conversion. An internal project over the past year has been completed that evaluated the feasibility and created a macro design of the proposed system (sunk costs). The data that has been collected is shown below: Data Block 0 1 2 3 Development Costs $1,000,000 Revenue without new software $3,000,000 $3,200,000 $3,500,000 Revenue With new software $3,000,000 $4,000,000 $5,000,000 COGS % 30% 30% 30% Marketing & Sales $25,000 $50,000 $75,000 Cloud Service $150,000 $165,000 $181,500 Depreciation %. 3 year MACRS 33.33% 44.45% 14.81% Tax rate 25% 25% 25% A three year time horizon is to be used for the evaluation, although the software is expected to be used much longer. The GPA tax rate is 25%.. Three-year MACRS depreciation has been chosen for the projects $1 million development and implementation cost. Note that the evaluation of the proposal is based on the difference that the proposal will make, since the goal is to evaluate the proposal. A similar situation is in discussion questions 8-8a and 8-8b. Submit a spreadsheet containing an Income Statement for this proposal. Use the standard Income statement format that includes totals for COGS, SG&A, EBIT and Net Earnings. No recommended decision is expected in this assignment as this requires a proposal cash flow statement that is next weeks topic.

Explanation / Answer

Data Block

Development Costs

$1,000,000

Sales annual % Increase W/O

10%

1

2

3

Revenue without

$2,500,000

$2,750,000

$3,025,000

$3,327,500

Sales annual % Increase With

33.33%

Revenue With

$2,500,000

$3,333,250

$4,444,222

$5,925,481

COGS %

50%

Marketing Expense

$75,000

$75,000

$75,000

Cloud Service annual change

10%

Cloud Service

$150,000

$165,000

$181,500

Depreciation %. 3 year MACRS

33.33%

44.45%

14.81%

Depreciation

$333,300

$444,500

$148,100

Book Value

$666,700

$222,200

$74,100

Tax rate

20%

MARR

15%

Sales of Servers

$50,000

Salvage Value

$300,000

AR annual decrease

15%

Account Receivable

$250,000

$212,500

$180,625

$153,531

Accounts Payable

($150,000)

($200,000)

($200,000)

($200,000)

Total Working Capital

$100,000

$12,500

($19,375)

($46,469)

Change in Working Capital

($87,500)

($31,875)

($27,094)

Year

0

1

2

3

Revenue Increase

$583,250

$1,419,222

$2,597,981

COGS

($291,625)

($709,611)

($1,298,991)

Gross Margin

$291,625

$709,611

$1,298,991

SG & A

Marketing Expense

($75,000)

($75,000)

($75,000)

Cloud Service

($150,000)

($165,000)

($181,500)

Depreciation

($333,300)

($444,500)

($148,100)

Total S.G.&A.

($558,300)

($684,500)

($404,600)

EBIT

($266,675)

$25,111

$894,391

Taxes

$53,335

($5,022)

($178,878)

Net Earnings

($213,340)

$20,089

$715,513

Cash Flow Statement

0

1

2

3

Net Earnings

($213,340)

$20,089

$715,513

Depreciation

$333,300

$444,500

$148,100

Investment

($1,000,000)

Salvage

$50,000

$300,000

Tax on gains

($10,000)

($45,180)

Change in W.C.

$87,500

$31,875

$27,094

Cash Flow

($1,000,000)

$247,460

$496,464

$1,145,526

PW

AW

IRR

$343,783

$150,568.95

30.31%

Data Block

Development Costs

$1,000,000

Sales annual % Increase W/O

10%

1

2

3

Revenue without

$2,500,000

$2,750,000

$3,025,000

$3,327,500

Sales annual % Increase With

33.33%

Revenue With

$2,500,000

$3,333,250

$4,444,222

$5,925,481

COGS %

50%

Marketing Expense

$75,000

$75,000

$75,000

Cloud Service annual change

10%

Cloud Service

$150,000

$165,000

$181,500

Depreciation %. 3 year MACRS

33.33%

44.45%

14.81%

Depreciation

$333,300

$444,500

$148,100

Book Value

$666,700

$222,200

$74,100

Tax rate

20%

MARR

15%

Sales of Servers

$50,000

Salvage Value

$300,000

AR annual decrease

15%

Account Receivable

$250,000

$212,500

$180,625

$153,531

Accounts Payable

($150,000)

($200,000)

($200,000)

($200,000)

Total Working Capital

$100,000

$12,500

($19,375)

($46,469)

Change in Working Capital

($87,500)

($31,875)

($27,094)

Year

0

1

2

3

Revenue Increase

$583,250

$1,419,222

$2,597,981

COGS

($291,625)

($709,611)

($1,298,991)

Gross Margin

$291,625

$709,611

$1,298,991

SG & A

Marketing Expense

($75,000)

($75,000)

($75,000)

Cloud Service

($150,000)

($165,000)

($181,500)

Depreciation

($333,300)

($444,500)

($148,100)

Total S.G.&A.

($558,300)

($684,500)

($404,600)

EBIT

($266,675)

$25,111

$894,391

Taxes

$53,335

($5,022)

($178,878)

Net Earnings

($213,340)

$20,089

$715,513

Cash Flow Statement

0

1

2

3

Net Earnings

($213,340)

$20,089

$715,513

Depreciation

$333,300

$444,500

$148,100

Investment

($1,000,000)

Salvage

$50,000

$300,000

Tax on gains

($10,000)

($45,180)

Change in W.C.

$87,500

$31,875

$27,094

Cash Flow

($1,000,000)

$247,460

$496,464

$1,145,526

PW

AW

IRR

$343,783

$150,568.95

30.31%