The engineering team at Manuel’s Manufacturing, Inc., is planning to purchase an
ID: 2510499 • Letter: T
Question
The engineering team at Manuel’s Manufacturing, Inc., is planning to purchase an enterprise resource planning (ERP) system. The software and installation from Vendor A costs $380,000 initially and is expected to increase revenue $125,000 per year every year. The software and installation from Vendor B costs $280,000 and is expected to increase revenue $95,000 per year. Manuel’s uses a 4-year planning horizon and a 10 percent per year MARR.
a. What is the present worth of each investment?
b. What is the decision rule for determining the preferred investment based on present worth ranking?
c.Which ERP system should Manuel purchase?
Explanation / Answer
Solution a:
Option 1 - Vendor A:
Software and installation cost = $380,000
Annual increase in cash inflows = $125,000
Period = 4 years
MARR = 10%
Present worth of investment = PV of cash inflows - Initial investment
PV of cash inflows = $125,000 * cumulative PV factor at 10% for 4 periods
= $125,000 * 3.169865 = $396,233
Net Present worth of investment = $396,233 - $380,000 = $16,233
Option 2 - Vendor B:
Software and installation cost = $280,000
Annual increase in cash inflows = $95,000
Period = 4 years
MARR = 10%
Present worth of investment = PV of cash inflows - Initial investment
PV of cash inflows = $95,000 * cumulative PV factor at 10% for 4 periods
= $95,000 * 3.169865 = $301,137
Net Present worth of investment = $301,137 - $280,000 = $21,137
Solution b:
Present worth - Vendor A = $16,233 - Rank 2
Present worth - Vendor B = $21,137 = Rank 1
The decesion rule for determining the preferred investment is option which is having higher net present worth should be preferred for investment.
Solution c:
As present worth of Vendor B ERP system is higher than Present worth of Vendor A. Therefore ERP system of Vendor B should be purchased
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