Maryville Environmental Services

The success of Maryville Environmental Services depends on Mike and Tim’s capital investment decision.  They must decide either to: (1) install a new information technology system or (2) update the existing information technology system.  Each alternative offers Maryville Environmental Services advantages and disadvantages in remaining a market leader in water engineering management.  Only time will tell if Mike and Tim made the right decision.  Such is the case for many difficult business decisions.  You need to work with Mike and Tim and help them make the best decision possible at this time with the available data.

The following conversation between Mike and Tim illustrate the challenges they face:

Mike:  Tim, I’m not sure what we should do about our information technology capital investment decision.  Should we simply purchase a new information technology system or update the existing system?  Our software vendor no longer supports the products we use, and our hardware is very old.  The competition provides higher quality consulting services than we do by leveraging information our current information technology system doesn’t provide.  To remain in business and operate competitively, we must change.  Yet, what is the best decision for today and for the many years to come?  What are the risks in purchasing a new information technology system compared to the risks in updating the existing system?

There are a number of different tools for analyzing a capital investment decisions, but some of the simplifying assumptions built into the models trouble me.  For example, how is it possible to forecast a specific increase in profitability three to six years from today, when the estimate is based on subjective data, such as, better customer information?  My gut feeling is that assumptions built into the tools have a significant effect on our information technology decision.

Tim:  Mike, I agree with your concerns, especially when we consider the intangibles.  Can the sales team actually grow revenues and increase cash flows with the additional customer information provided by the new or updated existing information technology system?

Mike and Tim face a difficult business challenge.  They must select an information technology system that offers the greatest short- and long-term benefits for Maryville Environmental Services and its workforce, and balance the benefits against the risk of changing the information technology system.  The managing partners request that you evaluate two mutually exclusive investment alternatives:  either to (1) purchase a new information technology system or (2) update the existing information technology system, and then make a recommendation to the managing partners.  When making your recommendation, you must make explicit the many assumptions that often comprise a capital investment decision.

Maryville Environmental Services believes they must improve their current information technology system to obtain the following potential benefits:

  • An efficient and effective inventory supply and contractor management system
  • The ability to capture more information on customer’s needs
  • The ability to capture and share information about engineering jobs among the engineering groups
  • A radio frequency identification (RFID) tracking system
  • A support staff that is more efficient and effective (Maryville Environmental Services offers retraining for a new position in the company to any support staff function eliminated as a result of information technology changes)
  • Resource consumption information must remain cost competitive

Maryville Environmental Services began operations in 1975.  The company provides water management engineering services for developers, city planners, and architectural firms nationwide.  Competitors view Maryville Environmental Services as the market leader in the water management systems industry.  Consequently, Mike and Tim must invest in a new or updated information technology system to meet customer needs and remain a market leader.

Maryville Environmental Services’ engagements span a wide range of services.  A routing engagement, for example, entails the design and engineering of residential housing development water management systems.  Specific services include detailed landscape plans for rainwater drainage, and the design for fresh water flow into the development as well as the flow of wastewater back into the drainage system.

An example of a complex engagement is the design and engineering of airport water management systems.  Services include the design of runway water management systems, complex and integrated water management systems for airport terminals, aircraft waste disposal systems, fire safety systems, restaurant support systems, and other facilities that serve a large population.  Maryville Environmental Services partners critically supervise the construction process of all jobs.  Moreover, customers appreciate the attention Maryville Environmental Services gives to every detail.  Projects currently at various stages of completion include residential developments, a hospital, and an airport.

Exhibit 1 contains information related to estimated costs and savings associated with the purchase of a new information technology system.

Exhibit 2 contains information related to estimated costs and savings associated with the update of the existing information technology system.


  1. Compute the payback period for the two alternatives.  Discuss the advantages and disadvantages of using the payback period to evaluate capital investment decisions.  Based on the results of the calculated payback period, which investment would you recommend that Mike and Tim pursue?
  2. Assuming the company requires an 7% return from capital investments determine the net present value of the two alternatives.  Discuss the advantages and disadvantages of using the net present value method to evaluate capital investment decisions.  Based on the results of the calculated net present value, which investment would you recommend that Mike and Tim pursue?
  3. Perform net present value calculations using the original cash flows but modifying the company’s required return from capital investment decisions.  First, assume the required rate of return is 5%.  Next, assume the required rate of return is 9%.  How would these modifications affect the recommendation that you would make to Mike and Tim?
  4. Assuming the company has a hurdle rate for capital investments of 7% determine the internal rate of return for the two alternatives.  Discuss the advantages and disadvantages of using the internal rate of return method to evaluate capital investment decisions.  Based on the results of the calculated internal rate of return, which investment would you recommend that Mike and Tim pursue?
  5. During a discussion with Mike, he indicated that he believes the cash flow estimates for the new system are very conservative.  He feels that the net cash flows will be 10% larger than the numbers provided in years 2 through 6.  Determine the revised payback period, NPV, and IRR with the updated cash flows for the new system.
  6. Discuss any significant assumptions that are required when using each of the capital investment tools.  Are there any concerns that you would want to bring to Mike and Tim’s attention related to these assumptions?
  7. What is your final recommendation to Mike and Tim?
Exhibit 1       
Purchase new system       
 Initial Outlay  Year 1  Year 2  Year 3  Year 4  Year 5  Year 6
Initial cash outflows       
  Hardware$ 1,750,000      
  Site preparation250,000      
  Initial systems design2,000,000      
Total initial cash outflow$ 6,000,000      
Recurring cash outflows       
  Hardware expansion $                0$      40,000$       80,000$    120,000$    160,000$    200,000
  Software 0150,000200,000225,000250,000275,000
  Systems maintenance 60,000120,000130,000140,000150,000160,000
  RFID tags and scanner 500,000450,000450,000400,000200,000100,000
  Communication charges 100,000160,000180,000200,000220,000240,000
  Networking charges 300,000420,000490,000560,000630,000700,000
Total cash outflows 960,0001,340,0001,530,0001,645,0001,610,0001,675,000
Cash inflows       
  Clerical and general overhead cost 60,000600,000700,000800,000900,0001,000,000
  Working capital 100,000300,000500,0001,000,000800,000800,000
  Profits from growing existing services 0900,000900,0001,200,0001,400,0001,500,000
  Profits from growing sales 0700,000800,0001,200,0001,600,0002,000,000
Total cash inflows 160,0002,500,0002,900,0004,200,0004,700,0005,300,000
Cash inflows less cash outflows (800,000)1,160,0001,370,0002,555,0003,090,0003,625,000
  Less income taxes 272,000(394,400)(465,800)(868,700)(1,050,600)(1,232,500)
  Cash inflows (outflows) net of tax (528,000)765,600904,2001,686,3002,039,4002,392,500
  Depreciation tax shield 297,500297,500297,500297,500297,500297,500
  Net cash inflows (outflows) (230,500)1,063,1001,201,7001,983,8002,336,9002,690,000
Exhibit 1       
Update existing system       
 Initial Outlay  Year 1  Year 2  Year 3   
Initial cash outflows       
  Hardware$   200,000      
  Site preparation100,000      
  Initial systems design800,000      
Total initial cash outflow$2,000,000      
Recurring cash outflows       
  Hardware expansion $                 0$                0$    200,000   
  Software 0100,000100,000   
  Systems maintenance 60,000100,000125,000   
  RFID tags and scanner 500,000300,000150,000   
  Communication charges 100,000160,000180,000   
  Networking charges 100,000150,000200,000   
Total cash outflows 760,000810,000955,000   
Cash inflows       
  Clerical and general overhead cost 500,000400,000300,000   
  Working capital 300,000300,000200,000   
  Profits from growing existing services 600,000750,000900,000   
  Profits from growing sales 600,000700,000800,000   
Total cash inflows 2,000,0002,150,0002,200,000   
Cash inflows less cash outflows 1,240,0001,340,0001,245,000   
  Less income taxes (421,600)(455,600)(423,300)   
  Cash inflows (outflows) net of tax 818,400884,400821,700   
  Depreciation tax shield 225,000225,000225,000   
  Net cash inflows (outflows) $ 1,043,400$ 1,109,400$ 1,046,700   

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