Mike McNeely, logistics manager for the Illumination Light Company, has considered replacing the firm's manual customer order management system with electronic ordering, a Web-based application. He estimates the current system, including labor, costs $2.50/order for transmission and processing when annual order volume is under 25,000. Should the order volume equal or exceed 25 ,000 in any given year, Mr. McNeely will have to hire an additional customer service representative to assist order reception in the manual process. This would raise the variable cost to $3.00/order. He has also estimated the rate of errors in order placement and transfer to be 1211 ,000 orders. A Web-based application would cost $100,000 upfront to implement and variable costs are determined to be $.50/order regardless of volume. A Web-based application could acquire and maintain order information with an error rate of 3/1,000 orders. A Web-based specialist would be required to maintain the system at all times as well. Her salary is $38,000 in the first year and increases 3 percent each year thereafter. Order errors cost $5.00 per occurrence on average to correct in the manual system. Web-based errors cost $8.00 on average to correct since the specialist inspects the system for flaws on most occasions.

a. If the firm expects order volume over the next five years to be 20,000, 22,000, 25 ,000, 30,000, and 36,000 annually, would a Web-based system pay for itself within the first five years?

The answer given was :

. To determine if EDI will pay for itself within the first 5 years, we must begin by determine the annual costs associated with the currents, manual customer order management system over this period:

Yr order volume x cost/order + error x cost/error =Annual cost

1 20,000 x $2.50 + (20,000x0.012) x $5.00 =$51,200

2 22,000x$2.50 + (22,000x0.012) x $5.00 =$56,320

3 25,000x$3.00 + (25,000 x0.012)x $5.00 =$76,500

4 30,000x$3.00 + (30,000x0.012)x $5.00 =$91,800

5 36,000x$3.00 + (36,000x0.012)x$5.00 =$11,0160

The calculative total cost of the manual system is $385,980

Now calculate the cost of EDI over the same period:

Yr order volume x cost/order + error x cost/error + salary = Annual cost

0 upfront implementation cost =$100,000

1 20,000x$0.5 + (20,000x0.003) x $8.00 + $38000 =$ 48,480

2 22,000x$0.5 + (22,000x0.003) x $8.00 + $38,000 x (1+3%) = $50,668

3 25,000x$0.5 + (25,000x0.003) x $8.00 + $38,000 x (1+3%)^2 = $53,414

4 30,000x$0.5 + (30,000x0.003) x $8.00 + $38,000 x (1+3%)^3 = $57,244

5 36,000x$0.5 + (36,000x0.003) x $8.00 + $38,000 x (1+3%)^4 = $61,633

The calculate total cost of EDI system is $371,439

By comparing the two total fiveyear cost, we can see that EDI would pay for itself within the first 5 years.

IS THERE SOMEWHERE IN THE BOOK THAT CAN EXPLAIN THIS BETTER...I HAVE LOOKED THROUGH THE 1ST 7 CHAPTERS & CANNOT FIND ANYTHING.