You are the business analyst for your organization and are trying to determine the best solution for an identified problem. You have determined that you could create a software solution using inhouse resources for $65,000 and with an ongoing support of $5,600 per month. A vendor offers you a quote that they can create the software for $49,000 with an ongoing support of $6,100 per month.
Which solution should you choose?
To determine which solution is financially better, you need to compare the total costs of both options over time. Let N be the number of months. For creating the software in-house, the total cost will be $65,000 plus $5,600 times N. For buying the software from the vendor, the total cost will be $49,000 plus $6,100 times N. To find the break-even point where the costs are equal, set up the equation 65,000 + 5,600N = 49,000 + 6,100N. Solving this, we get 16,000 = 500N, so N = 32. Therefore, if you use the solution for longer than 32 months, the in-house solution will be more cost-effective because its ongoing support costs are lower. Thus, you should create the software if you'll use the solution longer than 32 months.
65000 + (5600*N) = 49000 + (6100*N), 65000-49000 = 6100N-5600N, 16000=500N, N = 32 Option B is correct as you should use the solution longer than the pay back period.
Can someone please explain how they got this answer?
First, you have to calculate the time (N) at which the total cost of ownership for both solution approaches will be equal, 65000 + (5600*N) = 49000 + (6100*N), 65000-49000 = 6100N-5600N, 16000=500N, N = 32. Because the maintenance cost for create is $5600 and the maintenance cost for purchase is $6100, then it means that after 32months, we will incur less maintenance cost on the create option. Hence, Option B is correct.