You run a mail-order firm. You are considering replacing your manual ordering system with a computerized system, to make your operations more efficient and to increase sales. (All the cash flows given below are in real terms.) The computerized system will cost $11 million to install, and $470,000 to operate each year. It will replace a manual order system that costs $1,490,000 to operate each year. The system is expected to last 9 years, and have no salvage value at the end of the period. The computerized system is expected to increase annual revenues from $6 million to $8 million for the next 9 years. The costs of goods sold is expected to remain at 52% of revenues. The tax rate is 36%. As a result of the computerized system, the firm will be able to cut its inventory from 51% of revenues to 24% of revenues immediately. There is no change expected in the other working capital components. The real discount rate is 7%.
a. What is your expected cash flow at time=0?
b. What is the expected incremental annual cash flow from computerizing the system?
c. What is the net present value of this project?