QUESTION:

What are the after-tax cash flows for the ERP investment from 1999 to 2007? What is the present value of those cash flows?

Working Capital Reduction The company had 51 days sales of inventory (DSI) Of the 51 days, approximately eight days were reserved and allocated units, nine were in transit, and three were obsolete. The ERP system would enable FINCORP to make its supply chain more transparent and efficient, thereby eliminating the reserved, allocated, and obsolete units, and reducing the in-transit time. After a statistical study of its inventory, FINCORP developed a theoretical model target inventory level of 29 days. Project tlantic was forecasted to reduce 12 days of inventory in each Wave-over half of the difference between its actual inventory and the theoretical model inventory. Exhibit 3 shows data for 1997 including D5I by Wave. Exhibit 4 details the yearly percent DSI reduction in DSI by Wave. Revenue and Gross Margin Increase A primary goal of the ERP system was to increase product availability by making the supply chain more visible and by integrating sales forecasting and inventory management. The company's targeted product availability was 92%. The projections assumed that the ERP system and process changes would enable the company to realize an increase in unit sales equal to 25% of the improvement in product availability. Those incremental sales would contribute to increasing the profitability of FINCORP Exhibit 3 includes 1997 data on product availability, units revenne and margins by Wave. Exhibit 4 details the projected timing of the product availability improvements. The company's ability to evaluate profitability at a product line, account, or order level was hindered by the lack of an integrated information system. Decisions on prices, for example, were sometimes made with incomplete or dated information. By installing ERP, the company forecasted a 0.25% gross margin increase by the second year after implementation. To forecast the impact, the 1997 reverue as the baseline to apply the gross margin increase for each year of cash flow projections. Exhibit 5 presents the projected improvements by year and by wave company used Other Cost Savings The ERP system was expected to substantially simplify the processing and management of customer orders. An 18% reduction in the 79 order desk employees at an average cost of $40,000 per year per employee was expected once the system was implemented. The ERP system would also simplify the accounting function and result in a 15 % reduction in the 60 finance employees. The expected cost saving was 645,000 per year for each employee that was eliminated. The ERP system was also anticipated to generate other cost savings FINCORP paid about $40 annually for each square meter of warehouse space. With the reduction in inventory from the implementation of the ERP system, warehouse space could be reduced by 15 % ( 7,200 square meters). Also, customers returned 3 % of units they purchased, which cost FINCORP about $30 per unit returned. ERP was expected to reduce the number of returned units by eliminating shipping errors. The ERP system was also forecast to reduce bad debt expense and informnation system expenses. Exchibit 6 details these anticipated savings 2 Don- (Ending Inventery)/(COGS/Days in Peried) Costs Capital Expenditures The company would need to spend $4.3 million in 1999 for capital equipment, $S.6 million in 2000, S6.9 million in 2001, and $4.1 million in 2002. It would cost $600,000 and $300,000 for software licenses in 1999 and 2000 respectively. The capital equipment would be depreciated in equal amounts over five years. Implementation Implementation required extensive employee training; creation, testing, and documentation of new business processes; and, of course, installation of the ERP software. Implementation of each Wave would require an average of 50 current FINCORP employees working with external consultants at an expected cost of $45,000 for each employee. According to forecast, the company would need 19 consultants in 1999, nine in 2000, seven in 2001, and four in the following year, at an average monthly cost per consultant of 615, 400. To ensure compliance with the project plan, the company planned to put a three-person task force in place beginning in July 2000 through June 2004, at an annual cost of S600,000. On-going Operational Beginning in 2003, when all Wave implementations were completed, the cost to manage and maintain the new information systems was forecasted to be $3 million annually. However, because each Wave was scheduled to go on-line at a different time, costs would begin early in the program. Beginning in 1999, the company expected to incur $600,000 in annual expense, which would increase by an additional $600,000 each subsequent year through 2003, reaching $3,000,000 arnually. License maintenance fees were forecasted to begin in 2000 at a cost of $100,000 and increase an additional $100,000 each year through 2003, reaching $400,000 annually. These costs would continue until the system was replaced. Cost of Capital and Taxes FINCORP used a 9% cost of capital to discount the ERP project and faced a 40% tax rate. Exhibit 3 1997 Data for FINCORP Wave Product Availability DSI Units Sold Revenue Margin (000s USS) 58,859 46,241 43,678 29,818 (000s USS) 2271,139 1415.949 977 665 1,443,156 West 45 73.5% 477,784 283,549 185,625 280,901 South 51 83.1% 76.8% 83.2 % Central 67 North 55 Source: Company documents Exhibit 4 Improvements in DSI and Availability by Year and Wave Improvements by Year by Wave Wave 2000 2001 40% 2002 2003 2004 2005 West 25% 35% South Central North 35% 40% 25% 40% 40% 40% 20% 40% 20% Source: Company documents. Exhibit 5 Margin Improvements by Year by Wave Cumulative Margin Improvements by Year by Wave Wave West 2000 2001 2002 2003 2004 2005 0.06% 025% 0.25 % 025% 0.25% 0.25% 0.13% 025% 0.25% South Central North 0.10% 0.25% 0.13% 0.25% 0.25% 0 25% 0.25% 0.25% 0.25% Source: Company documents. Exhibit 6 Forecasted Other Expense Savings by Year (000s US$) 2001 2002 2000 2003 2004 2005 2006 2007 Order Desk Headcount 190 411 442 474 506 537 569 Finance Headcount 81 135 216 324 405 405 405 405 Warehouse Space 155 18 72 230 274 288 288 288 Bad Debt Expense 102 512 922 1,024 1,024 1,024 1,024 1,024 Information Systems 420 840 840 1.280 1.280 1,280 1.280 1,280 621 2.544 1,749 3,300 3,457 3,503 3,534 3,566 Source: Company documents. Working Capital Reduction The company had 51 days sales of inventory (DSI) Of the 51 days, approximately eight days were reserved and allocated units, nine were in transit, and three were obsolete. The ERP system would enable FINCORP to make its supply chain more transparent and efficient, thereby eliminating the reserved, allocated, and obsolete units, and reducing the in-transit time. After a statistical study of its inventory, FINCORP developed a theoretical model target inventory level of 29 days. Project tlantic was forecasted to reduce 12 days of inventory in each Wave-over half of the difference between its actual inventory and the theoretical model inventory. Exhibit 3 shows data for 1997 including D5I by Wave. Exhibit 4 details the yearly percent DSI reduction in DSI by Wave. Revenue and Gross Margin Increase A primary goal of the ERP system was to increase product availability by making the supply chain more visible and by integrating sales forecasting and inventory management. The company's targeted product availability was 92%. The projections assumed that the ERP system and process changes would enable the company to realize an increase in unit sales equal to 25% of the improvement in product availability. Those incremental sales would contribute to increasing the profitability of FINCORP Exhibit 3 includes 1997 data on product availability, units revenne and margins by Wave. Exhibit 4 details the projected timing of the product availability improvements. The company's ability to evaluate profitability at a product line, account, or order level was hindered by the lack of an integrated information system. Decisions on prices, for example, were sometimes made with incomplete or dated information. By installing ERP, the company forecasted a 0.25% gross margin increase by the second year after implementation. To forecast the impact, the 1997 reverue as the baseline to apply the gross margin increase for each year of cash flow projections. Exhibit 5 presents the projected improvements by year and by wave company used Other Cost Savings The ERP system was expected to substantially simplify the processing and management of customer orders. An 18% reduction in the 79 order desk employees at an average cost of $40,000 per year per employee was expected once the system was implemented. The ERP system would also simplify the accounting function and result in a 15 % reduction in the 60 finance employees. The expected cost saving was 645,000 per year for each employee that was eliminated. The ERP system was also anticipated to generate other cost savings FINCORP paid about $40 annually for each square meter of warehouse space. With the reduction in inventory from the implementation of the ERP system, warehouse space could be reduced by 15 % ( 7,200 square meters). Also, customers returned 3 % of units they purchased, which cost FINCORP about $30 per unit returned. ERP was expected to reduce the number of returned units by eliminating shipping errors. The ERP system was also forecast to reduce bad debt expense and informnation system expenses. Exchibit 6 details these anticipated savings 2 Don- (Ending Inventery)/(COGS/Days in Peried) Costs Capital Expenditures The company would need to spend $4.3 million in 1999 for capital equipment, $S.6 million in 2000, S6.9 million in 2001, and $4.1 million in 2002. It would cost $600,000 and $300,000 for software licenses in 1999 and 2000 respectively. The capital equipment would be depreciated in equal amounts over five years. Implementation Implementation required extensive employee training; creation, testing, and documentation of new business processes; and, of course, installation of the ERP software. Implementation of each Wave would require an average of 50 current FINCORP employees working with external consultants at an expected cost of $45,000 for each employee. According to forecast, the company would need 19 consultants in 1999, nine in 2000, seven in 2001, and four in the following year, at an average monthly cost per consultant of 615, 400. To ensure compliance with the project plan, the company planned to put a three-person task force in place beginning in July 2000 through June 2004, at an annual cost of S600,000. On-going Operational Beginning in 2003, when all Wave implementations were completed, the cost to manage and maintain the new information systems was forecasted to be $3 million annually. However, because each Wave was scheduled to go on-line at a different time, costs would begin early in the program. Beginning in 1999, the company expected to incur $600,000 in annual expense, which would increase by an additional $600,000 each subsequent year through 2003, reaching $3,000,000 arnually. License maintenance fees were forecasted to begin in 2000 at a cost of $100,000 and increase an additional $100,000 each year through 2003, reaching $400,000 annually. These costs would continue until the system was replaced. Cost of Capital and Taxes FINCORP used a 9% cost of capital to discount the ERP project and faced a 40% tax rate. Exhibit 3 1997 Data for FINCORP Wave Product Availability DSI Units Sold Revenue Margin (000s USS) 58,859 46,241 43,678 29,818 (000s USS) 2271,139 1415.949 977 665 1,443,156 West 45 73.5% 477,784 283,549 185,625 280,901 South 51 83.1% 76.8% 83.2 % Central 67 North 55 Source: Company documents Exhibit 4 Improvements in DSI and Availability by Year and Wave Improvements by Year by Wave Wave 2000 2001 40% 2002 2003 2004 2005 West 25% 35% South Central North 35% 40% 25% 40% 40% 40% 20% 40% 20% Source: Company documents. Exhibit 5 Margin Improvements by Year by Wave Cumulative Margin Improvements by Year by Wave Wave West 2000 2001 2002 2003 2004 2005 0.06% 025% 0.25 % 025% 0.25% 0.25% 0.13% 025% 0.25% South Central North 0.10% 0.25% 0.13% 0.25% 0.25% 0 25% 0.25% 0.25% 0.25% Source: Company documents. Exhibit 6 Forecasted Other Expense Savings by Year (000s US$) 2001 2002 2000 2003 2004 2005 2006 2007 Order Desk Headcount 190 411 442 474 506 537 569 Finance Headcount 81 135 216 324 405 405 405 405 Warehouse Space 155 18 72 230 274 288 288 288 Bad Debt Expense 102 512 922 1,024 1,024 1,024 1,024 1,024 Information Systems 420 840 840 1.280 1.280 1,280 1.280 1,280 621 2.544 1,749 3,300 3,457 3,503 3,534 3,566 Source: Company documents