Whirlpool Europe: What are the after-tax cash flows for the proposed ERP investment from 1999 through 2007?

Read the case “Whirlpool Europe” and the “Clarifications and Hints” section below and then try to answer the questions:
1. What are the after-tax cash flows for the proposed ERP investment from 1999 through 2007? What is the present value of those cash flows (that is, what is the NPV of the investment)?

2. Besides the three expected benefits from the project, are there other factors that are crucial for the project’s value? That is, identify three other factors that you think are value drivers and perform a sensitivity analysis regarding these factors.

Clarifications and Hints
Interpreting the information in the Case Text
Working capital reduction:
• DSI = Ending inventory/ (COGS/days in period)
The days in period is 365 since we are looking at annual data (forget leap years, for simplicity).
COGS means Costs of Goods Sold.
DSI is an inverse measure of inventory turnover, and tells us how long inventory is stored before it is sold (on average).
• Once we know how much DSI is reduced and what the COGS is (which can be calculated from Exhibit 3), we can use the above formula to find ending inventory, which in turn allows us to find the implied net working capital reductions.

Revenue and Gross Margin Increase:
• It is unclear from the case text exactly what the implication of an increase in product availability means for sales, so let me here explain it in more detail.
• The goal is to increase product availability to 92% for whatever it is in each respective Wave. A simplistic, but useful, interpretation of product availability is that we mean that the firm has the product in stock (“available”) when a customer shows interest in it. The firm then thinks that the increased availability will result in actual sales representing 25% of the increase in availability. That is, say that the firm currently has a product available for 72 out of 100 customers that ask for it. With the ERP system, the firm expects to have the product available for 92 out of 100 customers who ask for it. Thus, in an additional 20 instances the firm now has the product if a customer asks for it, and the firm then believes it will actually sell the product in 25% of those 20 extra instances. That is for every 100 customers, it can now sell an additional 25% x 20 units, i.e., 5 extra units. This we can now simplify into the following formula for forecasting the additional sales due to increase product availability:

The max increase in number of units sold = %-point increase in availability x 25% x number of units sold before new ERP system
Note that this max benefit does not incur directly, but is phased in over time according to the schedule in Exhibit 4.
• Once you have calculated the increase in the number of units sold per Wave, you can use that to predict revenues for each year, where you for simplicity can assume that the price/unit is constant over time for each Wave.
• Do not forget to account for the increase in profit margins as well as detailed in Exhibit 5!

Other cost savings:
• Note that the total savings are displayed in Exhibit 6.

Project Costs:
• Note that the capital equipment is depreciated down to zero over five years

Project Length:
• In your base case, assume the project ends at the end of 2007 and that there is no salvage value.

Interpreting the Case Exhibits
• Exhibit 3 shows the data for the different Waves in 1997. You can assume this is the data in 1999 as well. That is, you can for example use the revenue (=sales) in 1997 as the expected revenue in 1999. Then add any changes in sales (i.e., revenues) that you have forecasted for 2000 to this amount.

• The margin in Exhibit 3 is the dollar amount left after deducting costs of goods sold (COGS) from revenues. That is, Margin = Revenues – COGS. This is the gross profit.

• Exhibit 4 shows the improvement in DSI (Days Sales of Inventory) and product availability by Year and Wave. The percentages should be interpreted as the fraction of the total expected gain that is added any given year. That is, for year 2000 25% of the total benefit is added to Wave West. In 2001 an additional 40% of the total benefit is added to Wave West. The remaining 35% of the improvement occur during 2002 so that by the end of 2002 the full benefit of DSI improvements should have been added to the West Wave.

• The margin increases in Exhibit 5 are the percentage point increases to the profit margin percentage as of 1997. That is, if the margin increase for a certain Wave in 2000 is 0.06%, and the profit margin as a percentage in 1997 is, say 10% (fictional number), the margin in 2000 is 10% + 0.06% = 10.06%. To get the margin in dollar terms for 2000, you then multiply this fraction with whatever the forecasted revenues in 2000 are for that particular wave. Note, that unlike Exhibit 4, Exhibit 5 gives you the cumulative increase at that point.

• The other expense savings in Exhibit 6 are for the firm as a whole and not by Wave.

Other hints
• The best way to structure this case is probably to first look at each Wave separately, and then aggregate the items on firm-level at the end. However, be sure to keep pure company-wide effects separate from individual Wave effects.

• It is probably easiest to use an incremental approach. That is, calculate expected cash flows both with the ERP and without the ERP and then analyze the incremental cash flows.

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