Timberlake and Wood Limited is a garden centre retail business. Bernie Timberlake, one of the founders,...

 

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Timberlake and Wood Limited is a garden centre retail business. Bernie Timberlake, one of the founders, has decided that it is high time the company established a presence on the internet. He would like to start offering a mail-order service to customers that would allow them to purchase heavy items such as bags of fertiliser through the company's website. The goods would then be delivered direct to the customer's home. Bernie plans to offer only a limited range of goods via this medium - he doesn't want to discourage customers from visiting the garden centre to browse, as browsing generates a lot of sales. The company has looked at two principal options in respect of the website. They could buy a generic retailing program from a software house; this would require some amendment to customise it for the company's use. Also, there would be an annual license fee for seven years amounting to 10% of the initial purchase cost of the program. The alternative is to invest in software specially written for the company. This would be more expensive initially and would require a longer period for installation and testing. However, it could be better tailored to the company's specific requirements. Purchase of off-the-shelf software, including the required amendments, would cost £35 000 immediately. 10% of this sum would be payable as an annual licensing fee. Bernie estimates that the company could generate an additional £16 000 per year in revenue from website sales (this represents additional sales less sundry costs involved in running the system. It does not include the licence fee as a deduction). The first cash inflow would be assumed to arise in one year's time. If the bespoke software option is followed the initial cash outlay is estimated at £23 500, with a further £23 500 to be paid in one year's time provided the software is up and running properly. The company would generate an additional £18 500 in revenues (additional sales less sundry costs involved in running the system) under this option, but the cash inflows would not occur until the second year (for investment appraisal purposes, the first cash inflow will arise at time 2). In either case the project is expected to have a seven year life span. At the end of that period it is probable that significant investment in a new generation of software would be required. The company's cost of capital is 9%. Calculate for each investment: i) ii) The payback period ARR iii) Advise the company on which investment appears to be preferable, taking into account any other factors you think are relevant. Timberlake and Wood Limited is a garden centre retail business. Bernie Timberlake, one of the founders, has decided that it is high time the company established a presence on the internet. He would like to start offering a mail-order service to customers that would allow them to purchase heavy items such as bags of fertiliser through the company's website. The goods would then be delivered direct to the customer's home. Bernie plans to offer only a limited range of goods via this medium - he doesn't want to discourage customers from visiting the garden centre to browse, as browsing generates a lot of sales. The company has looked at two principal options in respect of the website. They could buy a generic retailing program from a software house; this would require some amendment to customise it for the company's use. Also, there would be an annual license fee for seven years amounting to 10% of the initial purchase cost of the program. The alternative is to invest in software specially written for the company. This would be more expensive initially and would require a longer period for installation and testing. However, it could be better tailored to the company's specific requirements. Purchase of off-the-shelf software, including the required amendments, would cost £35 000 immediately. 10% of this sum would be payable as an annual licensing fee. Bernie estimates that the company could generate an additional £16 000 per year in revenue from website sales (this represents additional sales less sundry costs involved in running the system. It does not include the licence fee as a deduction). The first cash inflow would be assumed to arise in one year's time. If the bespoke software option is followed the initial cash outlay is estimated at £23 500, with a further £23 500 to be paid in one year's time provided the software is up and running properly. The company would generate an additional £18 500 in revenues (additional sales less sundry costs involved in running the system) under this option, but the cash inflows would not occur until the second year (for investment appraisal purposes, the first cash inflow will arise at time 2). In either case the project is expected to have a seven year life span. At the end of that period it is probable that significant investment in a new generation of software would be required. The company's cost of capital is 9%. Calculate for each investment: i) ii) The payback period ARR iii) Advise the company on which investment appears to be preferable, taking into account any other factors you think are relevant.

Answer rating: 100% (QA)

i Payback period Option 1 Purchase of offtheshelf software Initial investment 35000 Annual Cash Inflow 16000 Payback period Initial InvestmentAnnual C... View the full answer