1. Economic Feasibility You are asked to conduct a five-year (Year 0 to Year 4)
ID: 1167919 • Letter: 1
Question
1. Economic Feasibility
You are asked to conduct a five-year (Year 0 to Year 4) economic feasibility study. Based on project schedule, you conclude that the system will not be in operation during the current year (Year 0). Once the system is operational in the following year (i.e. Year 1), you expect annual increased sales of $50,000 and inventory cost reduction of $14,000. You also estimate that the system benefit will increase $3,000 annually (from the previous year) from Year 2 through Year 4.
New computer costs $11,000 and the development cost is estimated at $77,500. The software license renewal and supplies will be $23,000 annually from Year 1 on. The initial personnel cost (incurred in Year 1) for hiring and training operators is $12,000, which will increase annually at a rate of 4% thereafter.
1) The discount rate is 7%. Is there a break-even point in the five-year time horizon? If so, when?
2) What is the ROI for the project?
Explanation / Answer
1) Break even point poin occurs when the revenue minus cost is equal to zero. The following table shows the present value of cost & benefit each year and cumulative ost and benefit each year:
The break even point occurs after year 1 and before year 2 since the net value of benefit and cost is zero between these years.
2) ROI, r can be found by equating the present value of cost to benefit with the help of IRR. This comes out to be 2%.
Year Discount factor(7%) Cost PV Cost Cumulative PV cost Benefit PV Benefit Cumulative PV benefit Present value of Benefit -Cost 0 1 88500 88500 88500 0 0 -88500 1 0.93457944 35000 32710.28 121210.2804 64000 59813.08 59813.0841 -61397.19626 2 0.87343873 35480 30989.61 63699.88645 67000 58520.39 118333.479 54633.59245 3 0.81629788 35979.2 29369.74 60359.35065 67000 54691.96 113212.353 52853.00189 4 0.76289521 36498.37 27844.43 57214.17477 67000 51113.98 105805.937 48591.76219Related Questions
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