Question

A business process outsourcing has the following avoided costs, incurred costs, and other characteristics:

• Costs avoided by outsourcing:
  • Salaries, wages, and benefits = $450,000 a year
  • Furniture and equipment = $100,000 a year
  • Supplies = $150,000 a year
  • Software = $10,000 a year
  • Facility rent/lease = $75,000 a year
  • Utilities and communications = $20,000 a year
  • Transition revenue now
    • Sale of unused assets = $10,000
• Costs incurred by outsourcing:
  • Payments to supplier = $440,000 a year
  • Contract administration = $30,000 a year
  • Transition cost now
    • Severance pay = $40,000
• 4-year time horizon
• Discount rate = 4% per year
• Assume all cash flows occur at the beginning of each year
• Assume “now” is the beginning of Year 1.

Use Excel to answer the following question. Based on the NPV of the cash flows, should this business process be outsourced?

Please show all the formulas used in excel.

Answer 1

NPV of Outsourcing Calculation
Time line	Now : Year 1 Beginning	Year 2 start	Year 3 start	Year 4 start
Costs Avoided by outsourcing :
Salaries & Wages	450,000	450,000	450,000	450,000
Furniture & Equipment	100,000	100,000	100,000	100,000
Supplies	150,000	150,000	150,000	150,000
Software	10,000	10,000	10,000	10,000
Facility Rent/Lease	75,000	75,000	75,000	75,000
Utilities/Communications	20,000	20,000	20,000	20,000
Transition Revenue Now
Sale of unused asset	10,000
Costs incurred by Outsourcing
Payment to Supplier	(440,000)	(440,000)	(440,000)	(440,000)
Contract Administration	(30,000)	(30,000)	(30,000)	(30,000)
Transition cost Now:
Severance Pay	(40,000)
Total Net Cash flow	305,000	335,000	335,000	335,000
Years for discounting	-	1	2	3
PV factor @4%	1	0.9615	0.9246	0.8890
PV of Net Cash flow	305,000	322,115	309,726	297,814
NPV of Net cash flow =	1,234,655
As the NPV of outsourcing is positive, the business process should be outsourced.