Question
As you already know, Paccar is considering either purchasing (buying) or developing in-house (building) new technology for their two major lines of trucks. Additionally, your
As you already know, Paccar is considering either purchasing (buying) or developing in-house (building) new technology for their two major lines of trucks. Additionally, your report suggested that the build option was riskier than the buy option but that was not quantified when estimating cash flows or our performance measures.Your original analysis has been criticized by a senior analyst in our group for not adjusting the discount rate for the differences in risk between buying and building.His specific concern was that your analysis used Paccar's WACC (5.5%) as the required return (discount rate) for both the buy and build alternatives and his suggestion was to adjust your quantitative analysis for the agreed fact that the build option is more risky (failure to develop, cost overruns, time delays, etc.) than the buy alternative.This senior analyst suggests that there is a need to apply the pure play approach, based on firms in the software development industry, to estimate the appropriate required return for the build alternative as an approach to adjust the analysis for the additional risk of building.
Mr. Harquest wants you to follow the senior analyst's suggestion (use the pure play approach: averaging the WACC of pure play firms) to determine the required return if we develop (build) the technology in house.More specifically, he suggests using Symantec Corp (SYMC) and Oracle Corp (ORCL) as your pure play firms.Does using the pure play estimate of the required return for the build alternative change your original quantitative results that the build alternative is our best choice?Mr. Harquest is also requesting your opinion regarding the appropriate required return for each alternative (buy or build the technology).Is the senior analyst's suggestion appropriate?Should the same required return be used for the both alternatives or does the build option require a higher return because of the added risk as the senior analyst suggests?If the same required return should be used for both alternatives should the required return be Paccar's WACC or the pure play firms' average WACC?Clearly present the logic behind your choice of required returns for each alternative.Ultimately, given your suggested required returns and the performance measures based on your suggestions, provide an updated recommendation on which alternative, buy or build, is best for Paccar.Additionally, do not forget to consider any remaining non-quantifiable factors.
Mr. Harquest is expecting a well written two page summary describing the purpose of the analysis, a discussion of which measure of required return is appropriate for each of the two investment alternatives, the results of your analysis given your chosen discount rates, the implication of these results, plus any consideration of the remaining non-quantifiable factors.Feel free to attach as many self explanatory exhibits as necessary.For the exhibit(s) used to estimate the required return based on the pure play approachclearly define variable used, equations applied, and sources for all data.Note: The following page provides helpful information regarding various websites to find the necessary data to do the pure play analysis.
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