Task:
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 $500,000. 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 $25,000 per year starting in year 0 and through all 5 years of the project to support production.
The current spending on this component (i.e. annual spend pool) is $875,000. The estimated cash flow savings of bringing the process in-house is 20% or annual savings of $175,000. This includes the additional labor and overhead costs required.
Your company has access to a credit line and could borrow the funds at a rate of 6%. 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 five years for $25,000. (i.e. the terminal value).
PART A: Data Calculations
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 PaybackDiscounted PaybackNet Present ValueInternal Rate of ReturnPart B: Recommendations
After completing the calculations for all scenarios, create a brief memo to the CEO outlining your committee’s recommendations. You may organize the memo as you see fit, but it must include the following:
A clear opening statement of your recommendation for or against the project. ? A brief synopsis of the processes and factors that led to your recommendations. o What information did you gather, and how did you get it?o From whom did you seek input, and why? A summary of the strategic benefits and risks in pursuing (or not pursuing) this project, including:o Highlights of the main data points that support your positiono Acknowledgement of the data points that oppose your argumento Identification of open/unresolved itemsAn identification of the scenario that, from a purely financial perspective, represents the most accurate estimate of the anticipated results and your rationale as to why.An identification of non-financial elements that need to be considered for the recommended scenario. ? Any assumptions in project economics can have a significant impact on the result. Identify 3 financial elements/assumptions in your analysis that would make this project financially unattractive. Be as transparent and candid with your BOD as possible. What would have to be true for this to be a bad investment?A summary restating your recommendation and key action items. Submission Requirements
Your memo should be no more than 2 pages, single-spaced, using 10- or 12-point font. Focus on the rationale for your recommendations. Include key numbers to support your recommendations, but do no re-present all your calculations.
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