Economic Feasibility

Assignment 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 $10,000 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.

• The discount rate is 7%. Is there a break-even point in the five-year time horizon? If so, when? What is the ROI for the project?
• Use the Goal Seek function or Solver from the Excel Tools menu, find out up to how high the initial personnel cost can be so that the NPV still remains positive.

The sum of computer cost and development cost is $10,000 + $77,500 = $87,500 (Initial cost for the ‘first year’).

The annual total cost is equal to the sum of the cost of license renewal and personnel costs = 23000 + 12000 = $34000

Year 1: Annual Total Benefit: $50,000 + $14,000 = $64,000

Now we can find the total benefit, personnel costs for each year. For this we use the formula:

• Total Benefit = Total Benefit (N-1 year) + $3000
• Personnel Cost = Personnel Cost (N-1 year) * 1.04

Thus, we get:

1. First year: Total Benefit = $64,000; Personnel Cost = $12000;
2. Second year: Total Benefit = $67,000; Personnel Cost = $12480;
3. Third year: Total Benefit = $70,000; Personnel Cost = $12979;
4. Fourth year: Total Benefit = $73,000; Personnel Cost = $13498;
5. Fifth year: Total Benefit = $76,000; Personnel Cost = $14038;

The total cost for each year:  The software license renewal and supplies will be $23,000 annually from Year 1 on. That’s why, we will add these $23000 to personnel cost for each year, thus we can get total cost.

1. Initial: Total Cost = $87500 (we found it in the beginning), PV factor = 1,0000
2. First year: Total Cost = $23000 + $12000 = $35000, PV factor = 0,9346
3. Second year: Total Cost = $23000 + $12480 = $35480, PV factor = 0,8734
4. Third year: Total Cost = $23000 + $12979 = $35979, PV factor = 0,8163
5. Fourth year: Total Cost = $23000 + $13498 = $36498, PV factor = 0,7629
6. Fifth year: Total Cost = $23000 + $14038 = $37038, PV factor = 0,7130

To find Net Cash Flow we must get the difference of total benefit and total cost:

1. Initial: NTF = $87500
2. First year: NTF = $64,000 - $35,000 = $29,000
3. Second year: NTF = $67,000 - $35,480 = $31,520
4. Third year: NTF = $70,000 - $35,979 = $34,021
5. Fourth year: NTF = $73,000 - $36,498 = 36,502
6. Fifth year: NTF = $76,000 - $37,038 = $38,962

NET PRESENT VALUE (NPV) = $50,531; To find that, we PV for each year by multiplying the cash flow that we found above to the PV factor which also we found above.

First:

• Discount Rate=7% and N=5 and Present Value factor=(1+0.07)*(-N). That’s what given. Break-Even point is the point at which total cost and total revenue are equal, which means that there is no loss for the business, based on the total cost and total benefit for each year that we found above, we can see that there is no year when the total cost and total benefit are equal. So, there were not equal. 
• ROI is a ratio between net income (over a period) and investment (costs resulting from aт investment of some resources at a point in time): ROI = 26% 

Second:

The highest the initial personnel cost can be so that the NPV still remains positive is equal to numbers between 23,436$ and 23,437.2$ (integer costs - 23,436$ and 23,437$).