Maryville Environmental Services Part 2/7

The success of Maryville Environmental Services depends on Mike and Tims capital investment decision. They must decide either to: (1) install a new information technology system or (2) update the existing information technology system. Each alternative offers Maryville Environmental Services advantages and disadvantages in remaining a market leader in water engineering management. Only time will tell if Mike and Tim made the right decision. Such is the case for many difficult business decisions. You need to work with Mike and Tim and help them make the best decision possible at this time with the available data.

The following conversation between Mike and Tim illustrate the challenges they face:

Mike and Tim face a difficult business challenge. They must select an information technology system that offers the greatest short- and long-term benefits for Maryville Environmental Services and its workforce, and balance the benefits against the risk of changing the information technology system. The managing partners request that you evaluate two mutually exclusive investment alternatives: either to (1) purchase a new information technology system or (2) update the existing information technology system, and then make a recommendation to the managing partners. When making your recommendation, you must make explicit the many assumptions that often comprise a capital investment decision.

Maryville Environmental Services believes they must improve their current information technology system to obtain the following potential benefits:

• An efficient and effective inventory supply and contractor management system
• The ability to capture more information on customers needs
• The ability to capture and share information about engineering jobs among the engineering groups
• A radio frequency identification (RFID) tracking system
• A support staff that is more efficient and effective (Maryville Environmental Services offers retraining for a new position in the company to any support staff function eliminated as a result of information technology changes)
• Resource consumption information must remain cost competitive

Maryville Environmental Services began operations in 1975. The company provides water management engineering services for developers, city planners, and architectural firms nationwide. Competitors view Maryville Environmental Services as the market leader in the water management systems industry. Consequently, Mike and Tim must invest in a new or updated information technology system to meet customer needs and remain a market leader.

Maryville Environmental Services engagements span a wide range of services. A routing engagement, for example, entails the design and engineering of residential housing development water management systems. Specific services include detailed landscape plans for rainwater drainage, and the design for fresh water flow into the development as well as the flow of wastewater back into the drainage system.

An example of a complex engagement is the design and engineering of airport water management systems. Services include the design of runway water management systems, complex and integrated water management systems for airport terminals, aircraft waste disposal systems, fire safety systems, restaurant support systems, and other facilities that serve a large population. Maryville Environmental Services partners critically supervise the construction process of all jobs. Moreover, customers appreciate the attention Maryville Environmental Services gives to every detail. Projects currently at various stages of completion include residential developments, a hospital, and an airport.

Exhibit 1 contains information related to estimated costs and savings associated with the purchase of a new information technology system.

Exhibit 2 contains information related to estimated costs and savings associated with the update of the existing information technology system.

Required: Please show ALL calculations and formulas used to answer the following questions.

This has 7 parts. I will post the other 5 parts once this is question is complete. I need to double check the math and make sure that we are not copying and pasting from other similar but different questions.

Question 1: Completed.

Question 2: Assuming the company requires an 7% return from capital investments determine the net present value of the two alternatives. Discuss the advantages and disadvantages of using the net present value method to evaluate capital investment decisions. Based on the results of the calculated net present value, which investment would you recommend that Mike and Tim pursue?

Exhibit 1 Purchase new system Initial Outlay Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year $ 1,750,000 1,050,000 200,000 250,000 2,000,000 750,000 $ 6,000,000 $ 0 0 Initial cash outflows Hardware Software Training Site preparation Initial systems design Conversion Total initial cash outflow Recurring cash outflows Hardware expansion Software Systems maintenance RFID tags and scanner Communication charges Networking charges Total cash outflows Cash inflows Clerical and general overhead cost Working capital Profits from growing existing services Profits from growing sales Total cash inflows Cash inflows less cash outflows Less income taxes Cash inflows (outflows) net of tax Depreciation tax shield Net cash inflows (outflows) 60,000 500,000 100,000 300,000 960,000 $ 40,000 $ 80,000 $ 120,000 $ 160,000 $ 200,000 150,000 200,000 225,000 250,000 275,000 120,000 130,000 140,000 150,000 160,000 450,000 450,000 400,000 200,000 100,000 160,000 180,000 200,000 220,000 240,000 420,000 490,000 560,000 630,000 700,000 1,340,000 1,530,000 1,645,000 1,610,000 1,675,000 60,000 100,000 0 600,000 300,000 900,000 700,000 2,500,000 1,160,000 (394,400) 765,600 297,500 1,063,100 0 160,000 (800,000) 272,000 (528,000) 297,500 (230,500) 700,000 500,000 900,000 800,000 2,900,000 1,370,000 (465,800 904,200 297,500 1,201,700 800,000 900,000 1,000,000 1,000,000 800,000 800,000 1,200,000 1,400,000 1,500,000 1,200,000 1,600,000 2,000,000 4,200,000 4,700,000 5,300,000 2,555,000 3,090,000 3,625,000 (868,700) (1,050,600) (1,232,500) 1,686,300 2,039,400 2,392,500 297,500 297,500 297,500 1,983,800 2,336,900 2,690,000 4 Exhibit 2 Update existing system Initial Outlay Year 1 Year 2 Year 3 $ 200,000 500,000 200,000 100,000 800,000 200,000 $2,000,000 $ S Initial cash outflows Hardware Software Training Site preparation Initial systems design Conversion Total initial cash outflow Recurring cash outflows Hardware expansion Software Systems maintenance RFID tags and scanner Communication charges Networking charges Total cash outflows Cash inflows Clerical and general overhead cost Working capital Profits from growing existing services Profits from growing sales Total cash inflows Cash inflows less cash outflows Less income taxes Cash inflows (outflows) net of tax Depreciation tax shield Net cash inflows (outflows) 0 $ 0 60,000 500,000 100,000 100,000 760,000 0 100,000 100,000 300,000 160,000 150,000 810,000 200,000 100,000 125,000 150,000 180,000 200,000 955,000 500,000 400,000 300,000 300,000 300,000 200,000 600,000 750,000 900,000 600,000 700,000 800,000 2,000,000 2,150,000 2,200,000 1,240,000 1,340,000 1,245,000 (421,600 (455,600) (423,300) 818,400 884,400 821,700 225,000 225,000 225,000 $ 1,043,400 $ 1,109,400 $ 1,046,700 Question 1: Compute the payback period for the two alternatives. Discuss the advantages and disadvantages of using the payback period to evaluate capital investment decisions. Based on the results of the calculated payback period, which investment would you recommend that Mike and Tim pursue? Exhibit 1 Current Year 1 Year 2 Year 3 Year 4 Year 3 Year 6 Purchase New Year System Year (0) Total initial $ 6,000,000 cash outflow: Total cash $960,000 $1,340,000 $1,530,000 1,645,000 1,610,000 1,675,000 outflows: Total cash 160,000 2,500,000 2,900,000 4,200,000 4,700,000 5,300,000 inflows: Net cash (230,500) 1,063,100 1,201,700 1,983,800 2,336,900 2,690,000 inflows (outflows); $3,045,000 Culminative $6,000,000) $6,230,500) $5,167,400) $3.965,700) $1,981,900) $355,000 Net Cash flow: Calculated Payback Period for Purchase New System: Payback Period: 4 Years +($1,981,900 Needed for year / Year 5 Net Cash flow) Payback Period: 4 Years +($1,981,900 /$2,336,900) Payback Period: 4 Years + (0.848) = 4.848 or 4.85 Years Year 1 Year 2 Year 3 Exhibit 2 Update existing system Total initial cash outflow: Total cash outflows: Total cash inflows Net cash inflows (outflows) Current Year Year (0) $2,000,000 760.000 2,000,000 $1,043,400 810,000 2.150.000 $1,109,400 955,000 2,200,000 $1,046,700 Culminative Net Cash flow ($2.000.000) ($956.600) $152.800 $1,199.500 Calculated Payback Period for Purchase New System: Payback Period: 1 year + (957,000 Needed for Year 2/ Year 2 Net Cash flow) Payback Period: 1 year +($957,000/$1,109,400) Payback Period: 1 year +0.862) = 1.862 or 1.86 Years There are positives and negative to using payback period as a method to evaluate capital investment decisions. One positive is that it is simple to calculate and fairly easy to understand. It also shows the amount of time which is needed in order for the company to recover its investment. However, the negative of this method is that it does not consider the time value of money. Meaning it assumes that the value of the dollar will stay the same over time. It sees that $1000 dollars today will be the same as the $1000 dollars received one year later. With all said if we were to only recommend our options based on the Payback Period method, we would recommend that we use the update Existing System option (Exhibit 2) since it as a lower Payback period. Question 2: Assuming the company requires an 7% return from capital investments determine the net present value of the two alternatives. Discuss the advantages and disadvantages of using the net present value method to evaluate capital investment decisions. Based on the results of the calculated net present value, which investment would you recommend that Mike and Tim pursue? Year 1 Year 3 Year 2 Year 4 Exhibit 1 Purchase New System Year 5 Year 6 Current Year Year (0) Total initial cash outflow: $6,000,000 Total cash outflows: Total cash inflows: Net cash inflows (outflows) Culminative Net Cash flow: $960,000 160,000 (230,500) $1,340,000 2,500,000 1,063,100 $1,530,000 2,900,000 1,201,700 1,645,000 4,200,000 1,983,800 1,610,000 1,675,000 4,700,000 5,300,000 2,336,900 2,690,000 ($6,000,000) ($6,230,500) ($5,167,400) $3,965,700) ($1,981,900) $355,000 $3,045,000 ? PV at 7% (0.07) ? PV of Cash Flow at 7%