Question: Salt Lake Systems is a small company started by two recent college graduates to market a small-business inventory management system they developed and patented as a class project. The system requires a special hard disk drive that plugs into a microcomputer. Buy and Modify Alternative: With this alternative, Salt Lake Systems would buy standard hard-disk systems at $2,200 and then modify them at a cost of $900 each. Annual fixed cash outlays for the modification operation would be $50,000. Capital investment requirements will be $30,000 to modify. Build Alternative: Under this alternative, Salt Lake Systems would construct the special hard-disk system from scratch. Component pans can be readily purchased, and the production process is not complex. The variable cost to build each special hard-disk system would be $2,000. Annual fixed cash outlays for the building alternative would be $100,000. Capital investment requirements will be $60,000 to build.
Salt Lake Systems plans to price the systems at $4,995 each because they have a patent and proprietary software. The partners estimate that they can complete 100 units a year, either building or modifying. Potential demand could be for thousands of units a year, but could also be only a fraction of capacity. The partners do not have enough information to estimate probabilities and cannot afford market research. They recognize that technology changes rapidly and, therefore, use a 3-year life for analysis. The cost of capital is 12 percent, and the partners are not subject to income tax. Use net present value break-even analysis to recommend a production method.