Question

Overview

In this assignment, you will take on the role of a senior member of the finance team assigned to lead the investment committee of a medium-sized telecommunications equipment manufacturer. Your team is evaluating a “make-versus-buy” decision that has the potential to improve the company’s competitiveness, but which requires a significant capital investment in new equipment. The assignment is organized into two parts:

Part A: Data calculations based on the information in the scenarios Part B: Recommendations based on the calculations

Opportunity Details

The new equipment would allow your company to manufacture a critical component in-house instead of buying it from a supplier. This capability would help you stabilize your supply chain (which has suffered from some irregularities and quality issues in the past). It could also have a positive impact on profitability through the absorption of fixed costs since this new machine will have plenty of excess capacity. There may even be a possibility that the company could leverage this capability to create a new external revenue stream by providing services to other companies.

The company has been growing steadily over the past 5 years, and the financials and future prospects look good. Your CEO has asked you to run the numbers. After doing some digging into the business, you have gathered information on the following:

• The estimated purchase price for the equipment required to move the operation in-house would be $750,000. Additional net working capital to support production (in the form of cash used in Inventory, AR net of AP) would be needed in the amount of $35,000 per year starting in year 0 and through all years of the project to support production as raw materials will be required in year o and all years to run the new equipment and produce components to replace those purchased from the vendor..

• The current spending on this component (i.e. annual spend pool) is $1,200,000. The estimated cash flow savings of bringing the process in-house is 20% or annual savings of $240,000. This includes the additional labor and overhead costs required.

• Finally, the equipment required is anticipated to have a somewhat short useful life, as a new wave of technology is on the horizon. Therefore, it is anticipated that the equipment will be sold after the end of the project (the last year of generated cash flow) for $50,000. (i.e. the terminal value)

• Input from Stakeholders

  As part of your research, you have sought input from a number of stakeholders. Each has raised important points to consider in your analysis and recommendation. Some of the points and assumptions are purely financial. Others touch on additional concerns and opportunities.

QUESTION

1. Eva from Engineering believes we use a higher Discount Rate because of the risk of this type of project. As such, she is recommending a 5-year project life and flat annual savings. Eva suggests that even though the equipment is brand new, the updated production process could have a negative impact on other parts of the overall manufacturing costs. She argues that, while it is difficult to quantify the potential negative impacts, to account for the risk, a 12% discount rate should be used. Being an engineer, Eva feels that the stated terminal value is low based on her experience, and is recommending a $75,000 terminal value,

Using the data presented above (and ignoring the extraneous information), for this profit and supply chain improvement project, calculate each of the following (where applicable):

• Nominal Payback

• Discounted Payback

• Net Present Value

• Internal Rate of Return

*These are the answers

Nominal Payback: 3.83

Discounted payback: 0.00

NPV: (3,463.86)

IRR: 11.8 %

Please show the steps to get to those answers. -Thanks

Answer 1

Solution :----

The Value Provided in this Question are :-

Initial Outlay = $ 7,50,000

Additional Working Capital = $ 35,000 Each Year

Terminal Value = $ 75,000 (Consider)

Discount Rate = 12%

1. Nominal Payback Period

2. Discounted Payback Period

3.Net Present Value at 12%

4. Internal Rate of Return