Plum Crazy

I'm actually working on a project right now which indicates why it is so important to use after-tax cash flow for calculating NPV. This deal is comparing a straight purchase of some software without upgrade rights now and a re-purchase of the upgrade licenses in 4-5 years vs. a three-year payout with a fourth-year renewal option which would give us the rights to deploy the upgrade licenses in year 4-5. The cost of the payout if you renew for the fourth year is slightly less than having to do two separate purchases. If you don't renew for the fourth year, it's substantially less, but there is risk of slippage on the delivery dates for the next versions of two key components of the deal which would mean that the upgrades wouldn't be delivered in the three-year timeframe, so we might have to renew for the fourth year to preserve our upgrade rights. To be conservative, therefore, we want to analyze the fourth-year renewal option in the financials.

What is interesting about this otherwise routine analysis is that the economics of this deal are going to be made or broken on the tax treatment of the three-year payout with the fourth-year renewal option. If we can expense the payout for tax purposes, then the NPV of the deal is more favorable than the NPV of the two separate purchases. This is solely because of the accelerated tax benefits of the expense. If we have to capitalize the payout, then the NPV of the deal is less favorable than the NPV of the two separate purchases. I don't often run across analyses where the tax treatment so dramatically affects the comparative economics, but they do occur infrequently. It's times like this when I scoff at those who scratch their heads at my insistence at looking at the after-tax cash flow when calculating the NPV. Seems many companies don't bother and can't figure out why I do so. Saps.