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: Tim, Im not sure what we should do about our information technology capital investment decision. Should we simply purchase a new information technology system or update the existing system? Our software vendor no longer supports the products we use, and our hardware is very old. The competition provides higher quality consulting services than we do by leveraging information our current information technology system doesnt provide. To remain in business and operate competitively, we must change. Yet, what is the best decision for today and for the many years to come? What are the risks in purchasing a new information technology system compared to the risks in updating the existing system?

There are a number of different tools for analyzing a capital investment decisions, but some of the simplifying assumptions built into the models trouble me. For example, how is it possible to forecast a specific increase in profitability three to six years from today, when the estimate is based on subjective data, such as, better customer information? My gut feeling is that assumptions built into the tools have a significant effect on our information technology decision.

Tim: Mike, I agree with your concerns, especially when we consider the intangibles. Can the sales team actually grow revenues and increase cash flows with the additional customer information provided by the new or updated existing information technology system?

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 and 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.

Exhibit 1
Purchase new system
	Initial Outlay	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Initial cash outflows
Hardware	$1,600,000
Software	1,000,000
Training	200,000
Site preparation	200,000
Initial systems design	1,500,000
Conversion	750,000
Total initial cash outflow	5,250,000
Recurring cash outflows
Hardware expansion		$ 0	$260,000	$300,000	$340,000	$380,000	$420,000
Software		0	150,000	200,000	225,000	250,000	275,000
Systems maintenance		60,000	120,000	130,000	140,000	150,000	160,000
RFID tags and scanner		500,000	450,000	450,000	400,000	200,000	100,000
Communication charges		100,000	160,000	180,000	200,000	220,000	240,000
Networking charges		300,000	420,000	490,000	560,000	630,000	700,000
Total cash outflows		960,000	1,560,000	1,750,000	1,865,000	1,830,000	1,895,000
Cash inflows
Clerical and general overhead cost		60,000	800,000	700,000	600,000	800,000	1,000,000
Working capital		100,000	300,000	500,000	1,000,000	800,000	800,000
Profits from growing existing services		0	900,000	900,000	1,200,000	1,400,000	1,500,000
Profits from growing sales		0	700,000	800,000	1,200,000	1,600,000	2,000,000
Total cash inflows		160,000	2,700,000	2,900,000	4,000,000	4,600,000	5,300,000
Cash inflows less cash outflows		(800,000)	1,140,000	1,150,000	2,135,000	2,770,000	3,405,000
Less income taxes		272,000	(387,600)	(391,000)	(725,900)	(941,800)	(1,157,700)
Cash inflows (outflows) net of tax		(528,000)	752,400	759,000	1,409,100	1,828,200	2,247,300
Depreciation tax shield		297,500	297,500	297,500	297,500	297,500	297,500
Net cash inflows (outflows)		(230,500)	1,049,900	1,056,500	1,706,600	2,125,700	2,544,800

Exhibit 2
Update existing system
	Initial Outlay	Year 1	Year 2	Year 3
Initial cash outflows
Hardware	$200,000
Software	300,000
Training	200,000
Site preparation	100,000
Initial systems design	1,000,000
Conversion	200,000
Total initial cash outflow	2,000,000
Recurring cash outflows
Hardware expansion		$ 0	$0	$200,000
Software		0	100,000	100,000
Systems maintenance		60,000	100,000	125,000
RFID tags and scanner		500,000	300,000	150,000
Communication charges		100,000	160,000	180,000
Networking charges		100,000	200,000	250,000
Total cash outflows		760,000	860,000	1,005,000
Cash inflows
Clerical and general overhead cost		500,000	400,000	300,000
Working capital		300,000	300,000	200,000
Profits from growing existing services		600,000	500,000	900,000
Profits from growing sales		600,000	400,000	800,000
Total cash inflows		2,000,000	1,600,000	2,200,000
Cash inflows less cash outflows		1,240,000	740,000	1,195,000
Less income taxes		(421,600)	(251,600)	(406,300)
Cash inflows (outflows) net of tax		818,400	488,400	788,700
Depreciation tax shield		226,667	226,667	226,667
Net cash inflows (outflows)		1,045,067	715,067	1,015,367

Required:

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?

2) Assuming the company requires an 8% 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?

3) Perform net present value calculations using the original cash flows but modifying the companys required return from capital investment decisions. First, assume the required rate of return is 6%. Next, assume the required rate of return is 10%. How would these modifications affect the recommendation that you would make to Mike and Tim?

4) Assuming the company has a hurdle rate for capital investments of 8% determine the internal rate of return for the two alternatives. Discuss the advantages and disadvantages of using the internal rate of return method to evaluate capital investment decisions. Based on the results of the calculated internal rate of return, which investment would you recommend that Mike and Tim pursue?

5) Discuss any significant assumptions that are required to use the capital investment tools that you used above. Are there any concerns that you would want to bring to Mike and Tims attention related to these assumptions?

6) What is your final recommendation to Mike and Tim?