Assuming a three-year time horizon and a tax rate of 20%, what is the NPV of outsourcing
Question:
Assuming a three-year time horizon and a tax rate of 20%, what is the NPV of outsourcing to CloudTech using a discount rate of 10%? Are there any potential “soft benefits to outsourcing that are not captured in the NPV analysis?
Assume that the $300,000 to upgrade servers is at the start of year 1. The $700,000 expenditure to CloudTech, the savings of IT worker salaries, and other savings are at the end of years 1, 2, and 3.
Metro Bank has 20 branches in the greater Tulsa area. Currently, the company has a fairly extensive IT department and uses it’s own servers to process transactions and store data. The annual budget for IT is $2,500,000.
James Baker, the chief financial officer at Metro, is considering outsourcing some of the IT work to CloudTech Services. Baker has a quote from CloudTech for $700,000 per year. He estimates that if he goes with CloudTech he’ll have the following savings:
1. The Bank will avoid spending $300,000 to upgrade servers and related software at the start of next year. The servers have a three year life with no salvage value and are depreciated using the straightline method.
2. IT worker salaries will be reduced by $400,000 per year.
3. There will be other miscellaneous savings of $100,000 per year.
Step by Step Answer:
To calculate the Net Present Value NPV of outsourcing to CloudTech we need to discount the cash flows associated with the decision The cash flows are the 300000 expenditure to upgrade the servers at the start of year 1 the 700000 expenditure to CloudTech at the end of years 1 2 and 3 the savings of IT worker salaries of 400000 per year and the other miscellaneous savings of 100000 per year Using a discount rate of 10 and a tax rate of 20 the NPV of outsourcing to CloudTech over a threeyear time horizon is calculated as follows Year 0 300000 expenditure to upgrade servers Year 1 560000 Net cash flow ...View the full answer
