Question

. Kurbe Marketing Research

Kurbe Marketing Research (KMR), located in Boston, specializes in marketing research in the consumer goods industry. Each year KMR conducts hundreds of research studies for a variety of clients utilizing focus groups, internet surveys and telephone surveys. KMR is currently studying the resources it dedicates to telephone surveys.

Demand for KMR’s telephone research varies throughout the year. KMR conducts the vast majority of its research in-house, but if it cannot handle all of the work at peak demand times, it is forced to subcontract some of the phone interviewing, which results in a lower profit margin. Also, outsourcing the phone interviews means that KMR loses some control of the process. This can result in problems such as missed deadlines and a decrease in quality. However, dedicating enough resources to ensure no outsourcing would not be very efficient, since it would result in more costs and decreased productivity due to idle time during slower periods. Nonetheless, based on the recent amount of outsourcing, KMR management feels that the company has too few operators conducting telephone survey research. You have been assigned the task of studying this problem and making a recommendation.

The annual fixed costs (management, facilities and other overhead charges) associated with the telephone survey group are $320,000. Every operator needs a computer-assisted telephone interviewing station (known as a CATI). Currently KMR has 48 CATIs and they are considering purchasing additional ones this year. Of the 48 CATIs currently on hand, 16 per year will be replaced each year for the next 3 years. New CATIs will not need replacement over this time period.

The purchase cost of a CATI is $36,000 and is likely to remain stable for the next 3 years. The cost of an operator (one per CATI) per month is $2,200. Assume that only additional CATIs (beyond the current number of 48) require training (replacement CATIs do not since they already have operators).

The time frame for the study is the next three years. Demand varies by month and forecasted demand for the coming year is shown in the table below (demand is expressed in dollars of revenue). A CATI can handle approximately $12,000 of work per month. Demand is expected to grow by 10% per year (the forecasted amounts in the table have already factored this in for next year). Assume that each month’s demand will grow by this amount in years 2006 and 2007. This increase in revenue will come from increased volume of work rather than increases in pricing (the forecast assumes stable pricing).

Month             Demand ($000)

January                        $890

February                      $820

March                          $575

April                            $860

May                             $695

June                             $330

July                              $740

August                        $700

September                   $255

October                       $750

November                   $170

December                    $160

Forecasted demand (in dollars of revenue) for 2005

Management is looking for the best level of in-house operation (number of CATIs). KMR receives 15% of the revenue for the work that is outsourced to an outside vendor. Finally, for studies such as this, KMR uses an annual discount rate of 10% and their tax rate is 34%.

a. Build a spreadsheet to help KMR analyze this situation. In your base case, evaluate the NPV of net income after taxes assuming KMR maintains 48 CATIs in all years.

You may use the following page to sketch your spreadsheet (although your sketch will not be graded). Your spreadsheet will be graded both for its technical correctness and for its adherence to the principles of spreadsheet engineering. Note, however, that documentation is not required, nor is extensive formatting for appearance.

b. Construct a graph on a separate sheet in your workbook to show the sensitivity of the NPV of net income after taxes to the number of CATIs. Sketch your results here, showing numerical scales for the horizontal and vertical axes, and clearly identify the optimal number of CATIs.

c. In the base case (with 48 CATIs) how much lower does KMR’s tax rate have to be to increase the NPV of net income after taxes by 10%?

Answer 1

Answer:

1)

Computation of number of employees:

Revenue:

Revenue per employee in-house = 12,000

Revenue from one outsourced employee = Revenue from inhouse employee * 15%

=>12,000 * 15%

=>1,800

Present value of cash inflows:

Total cost per year for employees = Number of employees * Cost per employee * 12 months

=>48 * 2200 * 12

=>1,267,200

.

Cost of computer:

Computer that has to be purchased in year 1 = 16 + 1 => 17 computer's

Computer that has to be purchased in year 2 and 3 = 16 computers per year

Cost of 17 computers = 36,000 * 17 =>612,000

Cost of 16 computers = 36,000 * 16 =>576,000

.

Present value of cash outflows = 612000 + 576000 / 1.10 + 576000 / 1.10^2

=>612,000 + 523,636 + 476,033

=>1,611,669

.

Net present value = Present value of cash inflows - Cash outflows

=>7,619,139 - 1,611,669

=>6,007,470

.

2)

Tax rate required to be decreased to increase the NPV by 10%

Increase in NPV required = 6,007,470 * 10% => 600,747

.

P.V Factor at 10% for 3 years = 2.486852

Increase in NPV required per year = 600,747 / 2.486852

=>241,569

.

Increase in NPV required is the decrease in tax rate required per year

.

Tax rate required to be reduced is found through IRR method

Tax rate required to be reduced approximately = Savings required / Net profit

=>241,569 / 4474400

.

Decrease in tax rate required is 5.4%, that is tax rate required to be 28.6%