Obsolete Computer Systems, Inc. wants to reemerge as a major producer of compute

Question

Obsolete Computer Systems, Inc. wants to reemerge as a major producer of computer software. The company has two options: Either it can purchase Upstart Software for $25m now whose products are expected to survive 5 years. Or it can develop an ongoing new line of software via research and development expected to cost $5m per year with implementation costs of $25m in 4 years. Using reasonable cash flow estimates from each product line, the Obsolete CFO has estimated that the internal rate of return from purchasing Upstart Software is 15% and the IRR of in-house R&D is 14%.As a member of Obsolete’s board of directors, you should vote against the CFO’s recommendation to purchase Upstart Software. (True, False, Uncertain and explain your response)

Explanation / Answer

Alternative 1 -To purchase upstart software now = $ 25 m

Alternative 2 -To pay $5 m per year for 5 years + $ 25 m in 4th year

                   = (PVAF@14%,5years * cash flow) +(PVF@14%,4year *cash flow)

                   = (3.43308 * 5 m) +(.59208 *25m)

                  = 17.1654 + 14.802

                  = $ 31.9674

*False ,As a member of board of directors I will vote in favor of CFO recommendation to purchase upstart software (and not against) as 1.The IRR of upstart software (15%) is more than in-house R and D (14%)

Also the cost of implementing in-hous R &D is more than cost of upstart software .

so I should vote in favor of CFO .

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