Bankserv, an IT company specialized in financial IT solutions is considering buying a new data
processing and management information system. The system, including computer hardware
and software, will cost $750,000. Delivery and installation of the system is expected to add
$5,000 to this cost. The system will be placed in a small building owned by the company.
The building is currently vacant and would be sold for $90,000 after tax in the absence
of the system. To put the new system in place, the company expects to invest $48,000
in net working capital immediately and increase $12,000 in net working capital at the end of year 1.
Bankserv has spent $27,000 on a feasibility study on the project. The system has an expected economic life of 10 years. It will be depreciated as a 7-year asset under
MACRS rules. Actual salvage value at the end of 10 years is expected to be $50,000 and the
company plans to sell the system for its savage value at that time.
The new data processing system will save the company a fee of $190,000 per year that it currently
pays to a computer time-sharing company. Operating, maintenance, and insurance costs for the
system are estimated to total $50,000 during the first year. These costs are expected to increase at a
rate of 7 percent per year over the 10-year period.
Bankserv plans to sell excess computer time to a number of local firms. The demand function for
this service during year 1 is estimated to be:
Q = 20,000 - 200P Where Q = number of units of computer time sold
P = price per unit of computer time sold An analysis of the local market for computer time makes the company believe that it can charge $14
per unit of computer time. Although Bankserv does not anticipate changing this charge over the 10-
year period, it expects the quantity demanded to decline by 5 percent per year after year 1. It is
expected that these outside sales of computer time will cost the company an additional $40,000 per
year in computer operating costs (including the salary of computer service representatives to handle
the new customers). These additional operating costs are expected to increase at rate of 7 percent
annually over the 10-year period. Bankserve has a marginal tax rate of 34 percent. This rate is expected to remain in effect over the
life of the project. The project will be financed 20 percent by debt and 80 percent by equity. The pre
-tax required rate of return on debt is 7.58 percent and the pre-tax required rate of return on equity is
15 percent. Inflation rate is assumed to be zero.
Based on the information contained in the case and whatever assumptions you feel you need to make, use
NPV approach to determine whether Bankserv should acquire the new data processing system.
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