## 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.