. Let's think about project evaluation issues related to starting and staffing at-home electronic device set-up and installation. Assume that Best Buy previously outsourced this assistance to third-party contractors. However, Best Buy believed that this was a higher margin business that would enable them to compete with Amazon and other retailers without local stores or service expertise. Therefore, they decided to create their own in-house team to perform these tasks.

This decision was about replacing one project with another. We are going to assume that the revenue that Best Buy gets from set-up and installation is the same, regardless of the decision. We are focusing on the costs associated with the transition - if Best Buy brings this service in-house, they will no longer have to pay contractors, but will incur new costs. Are these costs worth it?

Let's evaluate this decision by looking at what one store would have to do to create an in-house team.

I have provided you with cash flow data on the right. Assume that this decision was made back in 2007 (Year 0). We will then project out for six years (2008 - 2013). For simplicity, we will ignore any cash flows happening after 2013.

Projected Contracting Expenses Under Current System are the cash flows associated with hiring third-party contracters for installation work. This is what Best Buy would pay if they do not create their own in-house solution. Under the in-house solution, these cash flows are no longer paid.

Contracting Expenses Assuming Transition to In-House System are the cash flows duringthe period where some activities are still outsourced, while others are handled in-house. In-house work means that Best Buy no longer has to pay the contractors. Note that the savings do not appear until 2009, as the in-house solution is phased in.

Decrease in Costs from Outside Contractors is the total cost savings associated with bringing this service in-house. Note that these mirror the contracting expenses.

Costs Associated With In-House Solution gives variable and fixed costs per year if the store creates their own in-house team. I have given you data for 2008. Assume that each grows by 2.5% per year. Assume that any depreciation expense has been included in this total.

Start-Up Expenses gives expenses related to starting the in-house solution. These cash flows, if relevant, occur in Year 0, before operations start. Each store would need to pay $20,000 to an architectual firm that is contracting with Best Buy in order to set-up the space for the in-house team. Each store has already paid $10,000 for furniture that can be used for the in-house team. This furniture was used by the in-house Apple Store that is no longer present, once that contract with Apple ended. Remember - since these are expenses in Year 0, they will affect taxes paid in Year 0, which creates a cash flow.

Capital Expenses are cash flows that happen in Year 0, but are not expensed in Year 0. Instead, they should be depreciated using straight-line depreciation over the 6 year project life. This first is related to the vehicles that need to be purchased in order to do in-home installation work. The second is related to the equipment needed to do the installations and set-ups.

Net Working Capital captures the total net working capital needs associated with the project in each year. Each store must spend $30,000 in Year 1. This is then returned at the end of Year 6. Under the outsourced system, there were no working capital needs.

Set up a cash flow table for each year (Years 0 - 6). You'll need to find operating income (i.e. the cost savings from the project), other expenses, pre-tax income, taxes, and after-tax income. You'll also need to then to make the other necessary adjustments to get to total cash flows for the project.

Find the NPV and IRR of this project.

Then, do some sensitivity analysis.

Annual Cash Flow Data (2007-2013) 0 1 Year 2007 2008 2 2009 3 4 2010 2011 5 2012 6 2013 Projected Contracting Expenses Under Current System $ 750 000 $ 800 000 $ 820 000 $ 840 000 $ 880 000 $ 900 000 750 000 $ 400 000 $ $ $ $ $ 400 000 $ 820 000 $ 840 000 $ 880 000 $ 900 000 Contracting Expenses Assuming Transition to In-House System Decrease in Costs from Outside Contractors Costs Associated With In-House Solution Growth Rate Variable costs Fixed costs Total In-House Costs Start-Up Expenses Architectual Costs Furniture Costs Capital Expenses $ 20 000 $ 10 000 $ 150 000 $ 2,50% 153 750 2,50% $ 157 594 $ 2,50% 161 534 $ 2,50% 165 572 $ 2,50% 169 711 $ 275 000 $ 281 875 $ 288 922 $ 296 145 $ 303 549 $ 311 137 $ 425 000 $ 435 625 $ 446 516 $ 457 679 $ 469 120 $ 480 848 Vans and Other Vehicles $ 95 000 IT and Other Equipment $ 60 000 Net Working Capital Needs $ 30 000 Tax Rate 31% Cost of Capital 15% (30 000)