The Cloud Computing Company (CCC) has a contract with Vigilant Associates to mon
ID: 2647864 • Letter: T
Question
The Cloud Computing Company (CCC) has a contract with Vigilant Associates to monitor the availability of the software applications it hosts for its customers. The Vigilant contract costs CCC $100,000 per year, paid annually in advance. CCC is considering replacing Vigilant at the end of the current contract year with a software monitoring tool that it could use to perform the monitoring itself with no additional labor costs. The cost of the software is a one-time $200,000 perpetual license fee paid at the start of the engagement, followed by a $40,000 maintenance fee paid annually in advance. The software is expected to have a useful life of five years. The hurdle rate for CCC is 5%. Should the Company replace Vigilant with the software tool? Why or why not? How would your conclusion change if the hurdle rate was 20%?
Explanation / Answer
Annual cost of current system = 100000
PV cost of proposed system = 200000 + 40000 * (1-(1+.05)^-5)/.05
= 373179
AEC = 373179 / PVAF (5%, 5 years)
= 373179 / 4.329477
= 86195
Yes, system should be replaced.
If hurdle rate is 20%:
Annual cost of current system = 100000
PV cost of proposed system = 200000 + 40000 * (1-(1+.20)^-5)/.20
= 319624
AEC = 373179 / PVAF (20%, 5 years)
= 319624 / 2.990612
= 106876
No, system should not be replaced.