Eric, Benjamin, and Julia Are Partners in the Nannies of Ottawa

question 111

Essay

Eric, Benjamin, and Julia are partners in the Nannies of Ottawa (NOO). NOO maintains a pool of qualified nannies seeking both permanent and temporary employment in the greater Ottawa area. To manage their human resources more effectively, the three partners are considering an investment in new computer software. They are evaluating three different software solutions. Data for each is presented in the table below:
Package 1 Package 2 Package 3
Net present value $(100)$1,000 $500
Internal rate of return 7% 6% 4%
Payback (years)2 4 3
Accrual accounting rate of return 4% 5% 3%
a)List the steps NOO has taken, or will take, to evaluate the three software packages.
b)Based only on the results in the table above, which software package would you recommend? Why?
c)List two qualitative factors that could affect this decision.
d)Eric is strongly in favour of basing a decision on the payback period.
1)In your own words, explain the concept of "payback period."
2)If the partners take Eric's advice, which package will they purchase? Explain.
3)List one advantage and one disadvantage for using the payback method to make this decision.
e)Several terms associated with the net present value method are listed below. Define each term in your own words, and explain how each is used in completing an NPV analysis.
a)List the steps NOO has taken, or will take, to evaluate the three software packages.
b)Based only on the results in the table above, which software package would you recommend? Why?
c)List two qualitative factors that could affect this decision.
d)Eric is strongly in favour of basing a decision on the payback period.
1)The payback period provides information for decision-makers about the length of time it takes to return the cash cost of the investment to the organization.
2)If the partners take Eric's advice, they will choose Package 1, which has the shortest payback period.
3)One disadvantage of using payback for this decision is that it does not incorporate the time value of money and would encourage the partners to invest in a negative NPV project. One advantage is that it is relatively easy to understand. It also reduces potentially undue reliance on cash flows that are expected to occur further in the future.
e)
a)List the steps NOO has taken, or will take, to evaluate the three software packages.
b)Based only on the results in the table above, which software package would you recommend? Why?
c)List two qualitative factors that could affect this decision.
d)Eric is strongly in favour of basing a decision on the payback period.

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Definitions:

Standard Normal Variable

A random variable that follows a normal distribution with a mean of zero and a standard deviation of one.

Z-score

A measure of how many standard deviations an element is from the mean of its distribution.

Standard Normal Curve

A specific instance of a normally distributed curve where the mean is 0 and the standard deviation is 1.

Percentile

A statistical measure indicating the value below which a given percentage of observations in a group of observations fall.