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| Ultra Comp is a large information technology firm with several facilities. The firm’s Audit Committee has determined that management must implement more effective security measures at its facilities. A Security Improvement Team has been formed to formulate a solution. Janet Lynch is the financial analyst assigned to the team. She has determined that a six-year time horizon is appropriate for the analysis and that a 14% cost of capital is applicable. The team is investigating the following three vendors. Vendor A is a new entrant to the security industry and is in the process of introducing its security system which utilizes new technology. The system would require an initial investment of $4 million and have a life of six years. A net cash outflow of $500,000 per year for salaries, operation, maintenance, and all costs related to the system would also be required. Vendor B is an established firm in the security industry and has a security system that has been on the market for several years. The system requires an initial investment of $1 million and will have a useful life of three years. At the end of the three-year period, Ultra Comp would have to replace the hardware at an estimated cost of $1,250,000, based on current technology. A net cash outflow of $750,000 per year for salaries, operation, maintenance, and all other related costs would also be required. Vendor C is a nationally recognized firm in the security industry and has proposed to Ultra Comp that it provide a total security solution. Vendor C would provide all hardware and personnel to operate and maintain a security system as called for by the specifications of Ultra Comp for all its locations. Ultra Comp would be required to sign a six-year contract at a cost of $1,400,000 per year. Questions A. Ultra Comp utilizes the Net Present Value (NPV) method to quantify the financial aspects of corporate decisions. Calculate the NPV of each of the three alternatives. B. Based on financial considerations, which of the three alternatives should the team recommend? Explain why. C. Define sensitivity analysis and discuss how Ultra Comp could use this technique in analyzing the three vendor alternatives. D. Identify and briefly discuss three non-financial considerations that the Ultra Comp team should consider prior to making a recommendation to senior management. |