Hillsdale is considering two options for comparable computer software. Option A will cost $31,000 plus annual license renewals of $1,800 for three years, which includes technical support. Option B will cost $12,000 with technical support being an add-on charge. The estimated cost of technical support is $4,700 the first year, $3,700 the second year, and $2,700 the third year. Assume the software is purchased and paid for at the beginning of year one, but that technical support is paid for at the end of each year. The discount rate is 10%. Ignore income taxes. Required: Determine which option should be chosen based on present value considerations

Question

Business

Merlin

12 January, 12:39

Hillsdale is considering two options for comparable computer software. Option A will cost $31,000 plus annual license renewals of $1,800 for three years, which includes technical support. Option B will cost $12,000 with technical support being an add-on charge. The estimated cost of technical support is $4,700 the first year, $3,700 the second year, and $2,700 the third year. Assume the software is purchased and paid for at the beginning of year one, but that technical support is paid for at the end of each year. The discount rate is 10%. Ignore income taxes. Required: Determine which option should be chosen based on present value considerations

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Cruz Allison · Answer 1

Option B

Explanation:

The computation of the present value is shown below:

For Option A

Year Cash flows Discount factor at 10% Present value

0 - $31,000 1.0000 - $31,000.00

1 - $1,800 0.9091 - $1,636.36

2 - $1,800 0.8264 - $1,487.60

3 - $1,800 0.7513 - $1,352.37

Total - $35,476.33

For Option B

Year Cash flows Discount factor at 10% Present value

0 - $12,000 1.0000 - $12,000.00

1 - $4,700 0.9091 - $4,272.73

2 - $3,700 0.8264 - $3,057.85

3 - $2,700 0.7513 - $2,028.55

Total - $21,359.13

As we can see that the present value for option B is less than the option A so the option B should be selected