Computer Capital Budgeting Problem

FMIS 3201

Tim Peterson

You are given the assignment of justifying the purchase of a new information system for your company. The system being contemplated is a new CRM (Customer Relationship Management) system designed to improve your customer relations. The existing CRM is built using legacy technology and is very expensive to maintain plus it doesn’t offer features enabling E-commerce capability. Your company truly feels the new system will allow for better customer retention and increased annual sales volume. Historically, the company has lost customers through poor service and the inability to market and introduce new products to existing and new customers on a timely basis. This system is being viewed as an initiative designed to give the company a strategic advantage over their competitors through innovation.

You did your research on the acquisition through discussions with hardware and software vendors as well as interviewing key members of company management. You also spent a tremendous amount of time doing market research on the technology and surveying customer preferences. As a result of your inquiries, you determined the following facts related to the project. Your role is to develop an analysis using these facts leading to a recommendation on whether the company should acquire the new system. Your analysis should be a single page presentation highlighting your analysis and the facts used to make your recommendation. The analysis should be formatted for clarity and ease of use. In other words, the analysis should lead the reader to the conclusion in a smooth, orderly fashion with the conclusion clearly presented.

The costs of the system are as follows:

  1. The initial cost of the computer hardware is going to be $550,000, paid before the system is placed into use. There will be an annual hardware maintenance contract costing $50,000 per year.
  2. The purchase price of the software is $400,000 and is to be paid before the system is placed into use. The license agreement for the software calls for annual payments of $60,000 for the life of the software.
  3. The system life is expected to be three years
  4. There is no salvage value for either the software or the hardware. At the end of its life, the hardware and software will either be disposed or given away at no charge.
  5. The cost of training the employees to use the system will be $100,000 and will be paid before the system is placed into use.
  6. Consulting and programming necessary to implement the software will be $150,000. These services will be consumed and paid before the system is placed into use.
  7. No additional employees will be hired to maintain the system or to use it.
  8. You will have annual training and consulting costs each year for the life of the system at a cost of $35,000 and $25,000 respectively per year.

The benefits are as follows:

  1. It is estimated new sales will increase by 10% the first year and by 5% each year thereafter. The company’s revenues are estimated to be $20,000,000 by the time the new system would be ready for use.
  2. The company’s gross margin percent on the new sales is 40%. In other words, for each new dollar of revenue, $.40 will be available for the company after paying for the items sold.
  3. The new system will replace the expenses associated with the old system (the one being replaced). The old system costs $235,000 annually to maintain.
  4. The new system will eliminate the need for one computer operator at an annual salary of $65,000 plus benefits of $20,000.

Other factors you discovered relevant to this problem is:

  1. The company’s cost of capital for an investment of this nature is 11%. You can use this cost of capital rate for the interest in the calculation of the present value factors.
  2. The company likes all new projects to earn at least an ROI (Return on Investment) of 30% before they will consider authorizing the expenditure.

Should you recommend the acquisition of this Information System?

(Solution on following page)