Rachel is putting together a growth plan for ESI. She is evaluating whether to
substantially invest in company owned equipment, and whether to outsource her online
services personnel to a call center in New Dehli, India. Rachel has asked for your
analysis of the following two decisions facing ESI:
1. Equipment Purchase - ESI may decide to purchase outright additional computer
equipment. ESI can continue to lease equipment from hardware vendors. Such a
status quo decision comes with known margins and profitability metrics. The
status quo is embodied in the income statement and balance sheet reported in
202x data given above. Rachel believes adding owned equipment to its existing
leasing business will enable ESI to more fully utilize their fixed assets, grow
faster and provide more customized services to a larger group of future clients.
Rachel is proposing to purchase $500,000 of additional IT equipment. The
equipment would be installed and prepared for use in the current year. When fully
utilized the equipment would generate asset turnover of approximately 2x gross
investment. It would likely take four years to reach full utilization. The useful life
of equipment for accounting and tax purposes is 10 years. However, due to rapid
life cycles in enterprise technology, after six years Rachel expects to sell the
equipment for 10% of initial cost. The EBITDA (operating income plus
depreciation and amortization) margin of business done with owned equipment is
1.1x the margin of business done with leased equipment.