Critique the following statements:
It would cost us $800,000 to build this system, but we can purchase an equivalent package for $125,000. Therefore, we can save $675,000 by purchasing the software package.
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Build or Purchase Decision
In capital decision analysis and making, the end game should always be "what decision results to the most increase in stockholders' value." This value is often times associated with the company's stock price because it is usually the easiest measurement - shareholders can easily compute the value of their investment in the organization through market prices. In other words, the decision, in this case whether to build the system for $800,000 or purchase an equivalent package for $125,000, to be taken should be the one which leads to the higher stock price.
In analyzing the two choices, the decision maker needs to go beyond the obvious. A prudent manager wouldn't conclude off the bat that purchasing an equivalent package would save the company $675,000. It is much more complicated than that. This manager would know that an off the shelf software would require more maintenance, hence additional expenses related to periodic support from the vendor or developer of the system will need to be taken into account in the analysis.
Importance of capital budgeting
In support of the ultimate goal of management - shareholders' wealth maximization - it is important then that every use of "shareholders' funds" return with it the highest possible value. According to Byers, John and Wiley (1997) given in total quality management is the attention to quality standards. Now, buying off the shelf doesn't ...
The solution critiques statements about building or purchase a software package system.