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% per year MARR.
a) What is the discounted payback period of each investment?



b) Which ERP system should Manuel purchase if his decision rule is to select the system with the shortest DPBP?

Answer 1

Answer:

a.              VENDOR A

Year   Cashflow    [email protected]%      PV            Cummulative PV

               $                                 $                    $                    

  0        (380,000)        1       (380,000)      (380,000)  

   1        125,000       0.9091  113,638         (266,362)

   2       125,000       0.8264  103,300       (163,062)

   3        125,000      0.7513    93,913         (69,149)

   4        125,000      0.6830   85,375        16,226

   Discounted payback period

     = 3 years + $69,149/$85,375

     = 3.81 years

          Vendor B

Year   Cashflow    [email protected]%      PV            Cummulative PV

               $                                 $                    $                    

  0        (280,000)        1       (280,000)     (280,000)  

   1        95,000       0.9091  86,365         (193,635)

   2       95,000       0.8264  78,508        (115,127)

   3        95,000      0.7513    71,374         (43,753)

   4        95,000      0.6830   64,885        21,132

   Discounted payback period

     = 3 years + $43,753/$64,885

     = 3.67 years

The ERP should be purchased from vendor 2 because it has a shorter payback period.

Explanation:

In this question, we need to discount the cashflows for each project at 10% for 4 years. Then, we will calculate the cummulative present value by deducting the initial outlay from the cash inflows for each year until the initial outlay is fully recovered.