The operations department of a major FI is planning to reorganize several of its back-office functions. Its current operating expense is $1.5 million, of which $1 million is for staff expenses. The FI uses a 12 percent cost of capital to evaluate cost-saving projects.
a. One way of reorganizing is to outsource overseas a portion of its data entry functions. This will require an initial investment of approximately $500,000 after taxes. The FI expects to save $150,000 in annual operating expenses after tax for the next seven years. Should it undertake this project, assuming that this change will lead to permanent savings?
b. Another option is to automate the entire process by installing new state of- the-art computers and software. The FI expects to realize more than $500,000 per year in after-tax savings, but the initial investment will be approximately $3 million. In addition, the life of this project is limited to seven years, at which time new computers and software will need to be installed. Using this seven-year planning horizon, should the FI invest in this project? What level of after-tax savings would be necessary to make this plan comparable in value creation to the plan in part (a)?
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