Capital Budgeting

Tracy Turner, EVP of Like Magic, has called a meeting to discuss alternatives for the new computer system Like Magic has decided to purchase for order processing, inventory control, production scheduling, and sales forecasting. Like Magic plans to install the new computer system by the end of the year.
You summarize the important factors for the two computer systems being considered. The first choice is a system to handle the above applications and run the accounting applications currently being processed on a system Like Magic owns. With this choice, the existing system will be sold. The company plans to use the new system for 5 years, then replace it with advanced equipment. Fidel Fernandez, Purchasing Director, has obtained quotes for the hardware, software, and facilities of $180,000. He estimates this new equipment might be able to be sold for $36,000 after 5 years, but he has little confidence in that estimate. He also obtained a quote of $15,000 for the current system. You respond that the current system has a book value of $25,000, and therefore the resale would result in a loss. The company has decided that it will outsource operation of the new system. The cost of outsourcing will be $110,000 per year.
The second choice is to continue to run the accounting applications on the current equipment and buy a smaller system to run the new applications. If this choice is made, both the current and the new systems would be used for 5 years and then both would be replaced. Fidel estimates that the cost of this new system would be $90,000, and its resale value would be $18,000 after 5 years, but he also has little confidence in that amount. The current system will be fully depreciated in 2 years. The company estimates that outsourcing the operations of both systems will cost $125,000 for each of the next 2 years and $142,000 for years 3 through 5.
You decide to develop a spreadsheet model on your computer to help evaluate this decision. You will use both the NPV method and the IRR method in your calculations. You realize that the firm's cost of capital is 16% so therefore you choose to use this rate as the required rate.
REQUIRED:
DETERMINE BOTH THE NET PRESENT VALUE AND THE IRR FOR BOTH ALTERNATIVES.
WHICH ALTERNATIVE DO YOU RECOMMEND?
DISCUSS THE POTENTIAL EFFECTS OF INFLATION ESPECIALLY IF THE COMPANY DID NOT GET A GUARANTEED COST IN ITS OUTSOURCING AGREEMENT.