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?

Answer 1

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