Mini Case #4, Preliminary Cost-Benefit Analysis, page 33 Martin is working to de
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Question
Mini Case #4, Preliminary Cost-Benefit Analysis, page 33
Martin is working to develop a preliminary cost–benefit analysis for a new client-server system. He has identified a number of cost factors and values for the new system, summarized in the following tables: Development Costs—Personnel 2 Systems Analysts 400 hours/ea @ $50/hour 4 Programmer Analysts 250 hours/ea @ $35/hour 1 GUI Designer 200 hours/ea @ $40/hour 1 Telecommunications Specialist 50 hours/ea @ $50/hour 1 System Architect 100 hours/ea @ $50/hour 1 Database Specialist 15 hours/ea @ $45/hour 1 System Librarian 250 hours/ea @ $15/hour Development Costs—Training 4 Oracle training registration $3500/student Development Costs—New Hardware and Software 1 Development server $18,700 1 Server software (OS, misc.) $1500 1 DBMS server software $7500 7 DBMS client software $950/client Annual Operating Costs—Personnel 2 Programmer Analysts 125 hours/ea @ $35/hour 1 System Librarian 20 hours/ea @ $15/hour Annual Operating Costs—Hardware, Software, and Misc. 1 Maintenance agreement for server $995 1 Maintenance agreement for server $525 DBMS software Preprinted forms 15,000/year @ $.22/form The benefits of the new system are expected to come from two sources: increased sales and lower inventory levels. Sales are expected to increase by $30,000 in the first year of the system's operation and will grow at a rate of 10% each year thereafter. Savings from lower inventory levels are expected to be $15,000 per year for each year of the project's life. Using a format similar to the spreadsheets in this chapter, develop a spreadsheet that summarizes this project's cash flow, assuming a 4-year useful life after the project is developed. Compute the present value of the cash flows, using an interest rate of 9%. What is the NPV for this project? What is the ROI for this project? What is the break-even point? Should this project be accepted by the approval committee?
Explanation / Answer
Initial Cost = $143275
Systems Analysts = 2 x 50 x 400 = $40000
Programme Analysts = 4 x 250 x 35 = $35000
GUI Designer = 200 x 40 = $8000
Telecommunications Specialist = 50 x 50 = $2500
System Architect = 100 x 50 = $5000
Database Specialist = 15 x 45 = $675
System Librarian = 250 x 15 = $3750
Oracle training registration = 4 x 3500 = $14000
Development server = $18700
Server software = $1500
DBMS server software = $7500
DBMS client software = 7 x 950 = $6650
Annual Cost = $13870
Programmer Analysts = 2 x 125 x 35 = $8750
System Librarian = 20 x 15 = $300
Hardware, Software, and Misc. Maintenance agreement = $995
Maintenance agreement for DBMS software = $525
Preprinted forms = 15000 x 0.22 = $3300
Benefits = $199230
Year 1 = 30000 + 15000 = $45000
Year 2 = 33000 + 15000 = $48000
Year 3 = 36300 + 15000 = $51300
Year 4 = 39930 + 15000 = $54930
Cashflow
Year 1 = 45000 – 13870 = $31130
Year 2 = 48000 – 13870 = $34130
Year 3 = 51300 – 13870 = $37430
Year 4 = 54930 – 13870 = $41060
Present Value = Cashflow / (1 + 0.09) ^ number of years
ROI = (31130 + 34130 + 37430 + 41060 – 143275) / 143275 = 475 / 143275 = 0.0033 = 0.33%
Break Even point = Payback period = $102690 are recovered till the 3rd year and the remaining 40585 are recovered in the 4th year. Fraction of the 4th year = 40585 / 41060 = 0.99. Hence the payback period is 3 + 0.99 = 3.99 years.
NPV = Sum of the present values of all the cashflows.
The project should not be approved by the committee because it has a negative NPV a very low ROI and the break-even is achieved very close to the useful life of the project.
Year Cashflow Interest Present Value NPV 0 -143275 9% -143275.00 -$27,998.06 1 31130 9% 28559.63 Break Even 2 34130 9% 28726.54 3.99 years 3 37430 9% 28902.83 ROI 4 41060 9% 29087.94 0.33%