You run a mail-order firm, selling upscale clothing. You are considering replacing your manual ordering system with a computerized system, to make your operations more efficient and to increase sales. (All the cash flows given below are in real terms.)
- The computerized system will cost $10 million to instal, and $500,000 to operate each year. It will replace a manual order system that costs $1,500,000 to operate each year.
- The system is expected to last ten years, and have no salvage value at the end of the period.
- The computerized system is expected to increase annual revenues from $5 million to $8 million for the next ten years.
- The costs of goods sold is expected to remain at 50% of revenues.
- The tax rate is 40%.
- As a result of the computerized system, the firm will be able to cut its inventory from 50% of revenues to 25% of revenues immediately. There is no change expected in the other working capital components.
The real discount rate is 8%.
a. What is your expected cash flow at time=0? (1 point)
b. What is the expected incremental annual cash flow from computerizing the system? (3 points)
c. What is the net present value of this project? (1 point