Investment Cost Breakeven Analysis

[BULLRACER]

Hi,
I'm doing an analysis between continuing with the use of some current software or investing in new software and trying to determine the payback period of investing in the new software versus continuing to use the existing.

So current software costs $5,000 per annum but will require an additonal investment sometime in the future (say years 2 or 3) of $12,000.

New software will cost $10,000 upfront plus $3,000 per annum.

My equation to calculate the breakeven point was $10,000/($5,000-$3,000) to work out the breakeven point in years (5). However i'm not sure how to incorporate the $12,000 future investment into the formula given it will happen in the future (would like it to be a variable so i can plan with the numbers in a spreadsheet as to when that $12,000 investment is made).

Thanks,

 

[Ishuda]

Hi,
I'm doing an analysis between continuing with the use of some current software or investing in new software and trying to determine the payback period of investing in the new software versus continuing to use the existing.

So current software costs $5,000 per annum but will require an additonal investment sometime in the future (say years 2 or 3) of $12,000.

New software will cost $10,000 upfront plus $3,000 per annum.

My equation to calculate the breakeven point was $10,000/($5,000-$3,000) to work out the breakeven point in years (5). However i'm not sure how to incorporate the $12,000 future investment into the formula given it will happen in the future (would like it to be a variable so i can plan with the numbers in a spreadsheet as to when that $12,000 investment is made).

Thanks,

You really don't have enough information to solve your problem (although one might make some assumptions and solve the problem under those assumptions). The problem is something like an Internal Rate of Return problem [if there were a definite end of costs, it would turn into such if you were given all costs and treated either the new or old software use as income instead of cost]. As it is, you need to provide (or assume) a 'cost of money'. Let's assume you have been given that and the equivalent interest rate would be i, e.g. 10% per annum. Let x = 1/(1+i) and bring everything up to a present value and express money in thousands.

First, current software and assuming it is 2 years for the $12000 needed investment (at the beginning of year 3)
PV₁ = 12 x² + 5 x (1 + x² + x³ + ...+ x^n-1) = 12 x² + 5 x \(\displaystyle \frac{x^n\, -\, 1}{i}\)
where we have assumed that the $5000 yearly payment is made at the beginning of the year starting in year 2 for year two, and the break even point is at the end of year n. For example you make the $12K payment at the beginning of year 3 and make a $5K payment at the beginning of year 2, 3, and 4. Then n=4 and the break even is at the end of year 4 (beginning of year 5).

Next, the new software
PV₂ = 10 + 3 x (1 + x² + x³ + ...+ x^n-1) = 10 + 3 x \(\displaystyle \frac{x^n\, -\, 1}{i}\)

Set PV₁ = PV₂ and solve for n.

In a bit of a hurry so hope I haven't made a mistake. I don't think so but you never know.