Prepare a response to the following case study problem. Caledonia Services is looking to invest

in a new software platform. You have been tasked to decide if the cash flows from the project are

adequate: The following expectations for the project have been given to you:

Cost of new servers and building $11,000,000. Depreciation is over five years on a straightline

basis and at the end of five years the servers and building will be sold for an expected

$1,000,000.

 Fixed costs are $200,000 per year.

 Unit software sales from the new platform are expected to be as follows:

Year 1     50,000

Year 2     100,000

Year 3     150,000

Year 4     150,000

Year 5     100,000

 The product will sell for $300/unit in years 1-4; $250 in year 5

 Variable costs are $200/unit

 At the start of the project Caledonia will need $200,000 in cash for working capital. For years 1-

5 additional working capital will be needed equal to 10% of sales revenues. The cash flow

impact is the net increase/decrease in working capital in each year.

 There is a 35% tax rate and the company’s discount rate is 15%

 Determine the following:

 1)     Why should Caledonia focus on the project’s free cash flows versus the accounting profits

earned by the project in determining whether to fund the project?

2)     What are the incremental cash flows for the project in years 1-5?

3)     What is the projects initial cash outlay?

4)     What is the project’s net present value?

5)     What is the internal rate of return? 

6)     Should the project be accepted? Why or why not?

  Additionally, describe factors Caledonia must consider if they were deciding whether to do a lease versus buy.