You are an assistant in a department of a large insurance company. You are part of a systems feasibility study group which is investigating an upgrade in your department's computer systems. The project team is investigating the adoption of a new method of capturing customer data for certain insurance policies. The results of the study show that the use of this system could provide an average time saving of 15 minutes for each new policy file set up on the system. The estimated total cost per hour of the administrative staff who currently enter policy data is 40 per hour and about 18,000 policies of the type under review are sold each year. The sales volume of this type of policy is expected to be 18,000 policies next year rising to 21,000 the following year, 24,000 the next and settling 27 ,000 policies thereafter. The new system can be developed and implemented at a cost of 500,000. The new system will replace an existing system which was only implemented two years ago at a cost of 300,000. Both systems could operate for a further five years at which time the method of administering insurance products is expected to change. Neither system would be required after this time.

The written down value of the current system stands at 150,000 and the resale value of the hardware component is currently 100,000. This system would be expected to have a resale value of no more than 15,000 five years from now. The resale value of the new system would be about 80,000 five years from now.

Finally the new system would incur maintenance charges of 50,000 per annum as opposed to 30,000 per annum for the current system.

You have been asked to contribute to the study by providing a financial analysis of the proposed investment.

Tasks

(a) Using the net present value method prepare a discounted cash flow analysis of the proposed new systems. The cost of finance of the insurance company is estimated at 10%. lgnore the effects of taxation and inflation.

(b) Briefly explain how you could have introduced the effects of taxation and of inflation into your analysis