Question

Supply manager Joe Smith was considering the purchase of 1,000 desktop PCs for his organization. The life cycle was three (3) years and the organization’s cost of capital was 12%. He calculated the TCO for one of the purchase options as follows:

Cost Elements	Cost Measures
Purchase Price:
• Equipment	Supplier quote: $800 per PC
• Software License A	Supplier quote: $400 per PC
• Software License B	Supplier quote: $200 per PC
• Software License C	Supplier quote: $100 per PC
Acquisition Cost:
• Sourcing	2 FTE @ $65K and $75K per year for 2 months (Marty's note: hmmmmm Is this similar to opportunity costs?)
• Administration	1 PO @ $150, 12 invoices @ $40 each
Usage Costs:
• Installation	$300 per PC (PC move, install, network)
• Equipment Support	$60 per month per PC — supplier quote
• Network Support	$100 per month — supplier quote
• Warranty	$120 per PC for a 3-year warranty
• Lost Productivity	Downtime 25 hours per PC per year @ $30 per hour
End of Life:
• Salvage Value	$25 per PC

(MARTY'S NOTE: the Sourcing costs included in this case study are unusual. The dollar value of the two FTE for two months is probably accurate. However, in my experience, the sourcing costs did not include FTE wages because those are "sunk" costs and would have been blended into routine work or another sourcing requirement. I will appreciate your comments on this method and how opportunity costs are similar or different)

1. Determine the total cost of this contract over three (3) years.

2. Determine the present value of the three (3) year total cost.

3. How would you approach this supplier about reducing the total cost of ownership for computers over the life of this contract?

Answer 1

To easily understand the given information and the calculations we should make a table. I have used excel to put all the values.

We can use the following formulaes to calculate the desired values:

Now please note:

1. There are some costs that will be incurred inly in year 1. For such costs 0 is indecated in year 2 and 3.

2. All the costs are assumed to happen at the beginning of the year and salvage value is assumed at the end of the year

The above excel formula will give us the following solution:

Please note that as we are calculating cost thus salvage value is taken as negative as salvage value will be a incoming cash not a cost for the company.

Accouding to the above calculations:

1. total cost of this contract over three years is $3942860

2. present value of the three year total cost is $3726102.56

3. To reduce the cost of ownership over the life of this contract we can first approach the supplier to reduce the equipment support cists as those are the heighest among all the useage costs.

Moreover, costs of the equipment and different softwares could be negotiated to bring down the cost od the whole project.

Also note: In case there are some specific information about the costs such as lost productivity to be considered at the end of the year then the discounted value should be adjusted accordingly.

Sourcing cost as given in the case is a sunk cost as this cost will anyways occur thus this cost will not be taken for the calculation of project cost.

Administration cost is assumed to be incurred each year.

Installation cost is assumed to incur only once at the time of installation. It is also assumed that PC's once installed will not be moved.