Question

Zerox Corporation, a manufacturer of office equipment, is headquartered in Connecticut. Zerox stock (ZRX) is traded on all major exchanges. The price of common stock has languished in the $7-9 range, for the past several years. Annual sales are $18 billion. Zerox has been subject to intense domestic and internal competition in recent years, especially in the Office Copier Division (OCD). In response to the competition, OCD has changed the models of the copiers more frequently. In the past, any of the copier models were expected to remain in the market for 5 to 7 years. In response to the competition, OCD is changing each model in their product line every 3 to 5 years. This competitive tactic has increased market share. However, there has been a decline in productivity of repairing machines that are in the field. The Repair and Maintenance Operations (RMO) unit provided a detailed report on declining repair productivity. Their findings state that the more frequent introduction of new copier models, to replace existing models, has created a lack of familiarity in repairing copiers. The RMO report indicates that learning-by-doing has suffered. Statistical models of the learning curve indicate a 20% decline in productivity because of the frequent introduction of new models. The current labor costs for field repair and maintenance is $7,000,000 annually and is expected to stay at that level for several years. TRAINING EDGE The OCD problem, as described above, was turned over to the Professional Training (PT) unit of Zerox. PT has responded with a program proposal called the Training Edge. The proposal requires state-of-the-arts training for all field repair personnel. PT estimates that the Training Edge program will immediately restore the 20% loss of labor productivity. In other words, if you accept the project the loss of productivity goes away. Training Edge will require repair personnel to engage in five-day training programs annually to review the technical aspects of new copier models. The program will include virtual reality labs, physical repair labs, training videos, and manuals. A training center is also proposed at a site near corporate HQ, which is owned by Zerox and managed my Zerox Land. The building is currently leased for $575,000 annually. Fortunately, the lease expires soon. The lease provides a five-year option to renew at $575,000 annually, but can be cancelled by either party. Zerox can cancel the lease, which would provide an excellent training facility, though the current tenant would like to renew the lease. PT commissioned a study by Tonka Associates to consider retrofitting the building for training. The Tonka Associates study indicates that the lab space, classroom space, etc. will cost $900,000 to retrofit the building. Tonka was paid $47,000 for the study. PT estimates that annual operating expenses for Training Edge are: Videos $40,000 Training Manuals 20,000 Instructors 100,000 Instructional Material 5,000 Additionally, hotel-food-travel expenses for students visiting the training center from the several districts of OCD are estimated as $90,000 annually. THE FINANCIAL DECISION OCD is delighted with the concept of Training Edge. They have asked PT to develop a financial justification for the program. OCD wants the proposal to cover only the next five years, since senior Zerox management intends to sell the OCD at that time. The corporate tax rate is 35%. The training center building is fully depreciated. However, the retrofitting of the building is considered a capital improvement. It will be depreciated over the next three years on a straight-line depreciation basis. After "initial investments" today (retrofitting and so forth) all annual benefits and costs are assumed to occur at the end of the year, for each year over five years. Training Edge terminates at the end of five years and there are no salvage costs, etc., incurred at the end of the program. The required return for Zerox is 16%.

Answer 1

Training Edge
Year	0	1	2	3	4	5
Retrofitting costs	-900000
Savings in labor costs(7000000/1.2*0.2)		1166667	1166667	1166667	1166667	1166667
Opportunity cost of Loss of lease rentals		-575000	-575000	-575000	-575000	-575000
Annual opg. Expenses(40000+20000+100000+5000+90000)		-255000	-255000	-255000	-255000	-255000
Depn. Of retrofit		-300000	-300000	-300000
Incremental EBIT		36667	36667	36667	336667	336667
Less: Tax at 35%		-12833	-12833	-12833	-117833	-117833
Incremental EAT		23833	23833	23833	218833	218833
Add back: Depn		300000	300000	300000	0	0
Incl.OCF		323833	323833	323833	218833	218833
Total incl. annual cash flows	-900000	323833	323833	323833	218833	218833
PV at 16%	1	0.86207	0.74316	0.64066	0.55229	0.47611
PV at 16%	-900000	279167	240661	207466	120860	104189
NPV of the decision	52343
Project Training Edge is recommendable for its POSITIVE NPV.