A retailer has proposed the development of a customer service, mobile application as a means to increase sales and customer loyalty. This new service system will provide personalized purchasing suggestions and advice to each consumer based on predictive models that the company will develop from big data. The project plan for this service innovation calls for supporting a team of app developers for several months to design, debug and test the mobile application. After rolling out a beta version, the team will refine the app into its final form. After this revision, the application will be deployed in two phases to the retailers markets. In parallel with the app development, the team from the marketing department of the company will work with a consulting company to design the service innovations that will be enabled by the application. A team of data analysts will tackle the challenging problems of identifying, acquiring, cleansing and analyzing the big data from which predictive models will be built, validated and tested. By company policy, the projected cash flows of this service innovation project are discounted at an annual rate (APR, not APY) of 16% due to the high risk of failure or expensive delays in this kind of project. The company also sets a limit of 5 years on the horizon for investments of this kind because of the likelihood of obsolescence of the software product within this time horizon. Financial cash flows are analyzed on a monthly basis. Revenue projections are based on the sales forecasts of the effectiveness of the new services.
Table 1 shows the projections for the costs and revenues of this project. All monthly costs and revenues are recognized at the ends of the months indicated. Cash flow discounting is calculated on a monthly basis. Table 1.1:
Cash flow data Project Phase Months Expected Cost ($ 000 per month) Expected Revenue ($ 000 per month)
Service System & App Design 1 - 6 80
Data Specification 1 - 3 10 Data Collection 4 - 6 40
Data Cleansing 5 - 8 5
Model fitting, validation, testing 6 - 12 50
App Development 5 - 14 40
Beta Test 15 - 24 20 25
System Revisions 18 - 24 15
Rollout Phase 1 25 - 36 80
Rollout Phase 2 37 - 60 150
a. Cash flow analysis. Please show your calculations for NPV and Payback Period.
b. What is the payback period for this project?
c. What is the net present value of this project?d
d. Should the company go forward with this project? Explain your answer.
e. How sensitive is the profitability of this project to the company’s discount rate (APR)? What is the discount rate at which the NPV is zero? Explain your answer.