XYZ, a software house is considering developing a payroll application for use in academic institutions

Question: XYZ, a software house is considering developing a payroll application for use in academic institutions and is currently engaged in a cost-benefit analysis. Study of the market has shown that, if XYZ can target it efficiently and no competing products become available, it will obtain a high level of sales generating an annual income of $800,000. It estimates that there is a 1 in 10 chance of happening. However, a competitor might launch a competing application before its own launch dates and then sales might generate only $100,000 per year. It estimates that there is a 30% chance of this happening. The most likely outcome it believes, is somewhere between these two extremes – it will gain a market lead by launching before any competitor product becomes available and achieve an annual income of $650,000. Initially, draw a table presenting the expected value ($) for high, medium and low sales. Show the total expected income. Development costs are estimated at $750,000. Sales levels are expected to be constant for at least four years. Annual costs of marketing and product maintenance are estimated at $200,000, irrespective of market share. Would you advise going ahead with the project? Give detailed explanation.

Solution:

Income,Expected Value

High Sale, 1/10 * 800,000 = $80,000

Sale Low, 3/10*100,000 = $30,000

Medium Sale, 6/10*650,000 = $390,000

Expected Sales Level = 1/10*800,000 + 3/10*100,000 + 6/10*650,000

= $80,000 +  $30,000 + $390,000

= $500,000

Development Cost = $750,000

Annual Cost = $200,000

Total Cost over four years

= development cost + 4* Annual Cost

= $750,000 + $800,000

= $1,550,000

Total revenue over 4 years = $2,000,000

Profit = $450,000

Yes it is advisable to go ahead with the project as the firm is operating in profit.

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